March 6, 2023
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GODREJ CONSUMER, Lower RM cost, GAUM turnaround to boost growth
Call & Research Report by Motilal Oswal
Sector: Consumer
CMP Rs. 926, Target Rs. 1080 (17% upside potential)
Target Period: 12 Months
Godrej Consumer (GCPL) is one of our top pick from our Staples Coverage Universe over a
one-year horizon. We present here our investment rationale:
● Increasing traction in the domestic business should improve margins and return ratios.
● The focus on profitability improvement in the African region (GCPL’s second largest sales contributor) and continued discipline in capital allocation will reduce the historical drag on the overseas businesses.
● Among staples, GCPL is the key beneficiary of the recent reduction in material costs. Palm oil prices have come off significantly, and even if a reasonable share of this gain is spent on advertising, it will boost EBITDA growth from 4QFY23 onward.
● While the company’s target of achieving sustainable double-digit sales growth in Household Insecticides (HI) could be delayed, its other domestic segments are showing signs of promising traction.
● The valuation is inexpensive at ~34x FY25E EPS for a business that is expected to report a ~28% earnings CAGR over the next two years and RoCE of over 20% for the first time since FY11. Our SoTP based valuation gives us a target price of INR1,080, representing a 17% upside on the CMP.
Increasing salience of the profitable and high-ROCE domestic business:
● After a few years of lull in the latter half of the last decade, GCPL’s domestic business has been reporting a double-digit CAGR over FY20-FY23E. Salience of the domestic business, where margins are more than 2x that of the international business and ROCE is several times higher, has risen significantly from ~52% of sales in FY17 to ~56% of sales in FY22 and is poised to reach close to 60% of sales in the next few years, elevating consolidated margins, earnings growth and return ratios.
● Better capital allocation overseas: Even before growth in the domestic business resumed in recent years, there were signs of more disciplined capital allocation towards the end of the last decade, a process that has continued subsequently under the new CEO. Management’s focus on improving profitability and working capital in Africa, as stated in the recent analyst meet, is another welcome move.
● Palm oil cost reduction leading to sharp gains: Higher palm oil prices materially affected GCPL’s earnings in the last few quarters. The prices are now down ~49% from the peak, and GCPL, among staples, will be the key beneficiary of the price reduction in the next few quarters. Even if GCPL spends some of the gains to shore up advertising, the company could see a healthy earnings growth of 25-30% in the next few quarters.
● Improvement in management bandwidth through external hiring: In the last few months, GCPL bolstered its management bandwidth by replacing the ASEAN head and appointing a new head of Business Transformation and Digital; both came from the Unilever stable. We believe the key benefits of new appointments are the eventual cost rationalization (a key success area for Unilever in emerging markets) and the reduction in gaps with MNCs on data analytics.
► Mr. Rajesh Sethuraman was appointed as the Business Head of the ASEAN region. He has 26 years of work experience, the majority of which he spent at Unilever, leading teams across categories and divisions in South Asia and SubSaharan Africa.
► Mr. Vijay Kannan was appointed as the Head of Business Transformation and Digital. He has over 19 years of work experience in the Consumer Goods and Energy industries. He previously worked as the Global Chief Information and Digital Officer of global lubricants business of Shell, and the IT head of HUVR.
► We believe GCPL is likely to tap more talent from larger peers like Unilever to further improve its management bandwidth.
Valuation and view
● GCPL’s domestic businesses had demonstrated strong sales growth in the first half of the last decade, before losing steam in the second half. Domestic and consolidated sales growth crossed double digits in the last two years and appears to do so in FY23 as well, far better than the 4.1% sales CAGR between FY16 and FY20.
● We expect GCPL to be the key beneficiary of the sharp reduction in raw material costs (especially palm oil) from the peak over the next few quarters.
● With the new CEO focusing on improving growth in the high-margin, high-RoCE domestic business, as highlighted in our recent CEO meet note, GCPL’s mediumterm earnings growth outlook is strong. The valuation at ~34x FY24E EPS is inexpensive and is at a steep discount to peers. We maintain our BUY rating with a TP of INR1,080 (based on SoTP valuation: 50x domestic business, 20x Indonesia business, 15x GAUM and other business ).
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