Valuation in Motion: Godrej Consumer Products Limited Valuation: Share of Mind

thumbnail
Reading Time: 12 minutes


Hair colors, hair care, hair salons, mosquito repellents, household insecticides, bathing soaps, air fresheners, wet tissues, liquid detergents: These products cover the impressive breadth of the consumer needs this company solves. Godrej Consumer Products Limited. If you haven’t heard the name, you have most probably used the company’s products at least once in your life. There’s been a fresh correction in the price of the stock that’s got the market wondering about the company’s intrinsic value.

The Company

Godrej Consumer Products Limited (GCPL) needs no introduction in the Indian market – at least, their products don’t. GCPL’s leadership team is impressive. The company is led by the most venerable Mr. Adi Godrej as the Chairperson Emeritus, Ms. Nisa Godrej (Daughter), recently promoted to Chairperson & Managing Director and Mr. Vivek Gambhir as the Chief Executive Officer & Managing Director. Although GCPL has its feet firmly placed in India, they are also exploring opportunities in Indonesia, Africa and Latin America.

Today, they rank among the largest household insecticide and hair care players in emerging markets. In household insecticides, they are the leader in India, the second largest player in Indonesia and are now expanding their footprint in Africa. They are the leader in hair extensions in Africa, the number one player in hair color in India and Sub-Saharan Africa and among the leading players in Latin America. They rank number two in soaps in India and are the number one player in air fresheners and wet tissues in Indonesia. As already discussed, their products range a wide span, generally categorized as Hair Care, Personal Care and Home Care.

More noticeable and profitable to the company are the following brands specifically:

Business Analysis – SWOT Analysis

Strengths

  1. GCPL’s products are spread across different value chains. This diversification allows them to efficiently allocate capital based industry cycles in specific categories.
  2. Presence in several countries also adds a sort of diversification benefit. But more importantly, it allows the company to learn lessons on-the-go, instead of waiting for a strategy to play out in a single market. Cross-implementation of strategies is a massive benefit to the company.
  3. Innovation is synonymous with the company’s name. Over the years, the company has been able to identify customers needs and launch new, improved products to cover them. For instance, the company has recently launched a line of incense sticks. The incense sticks markets is largely unorganized or illegal in India.
  4. The management is strong and knowledgeable.

  • Vivek Gambhir, the CEO, is responsible for implementing the company’s core 3×3 strategy (Presence in 3 major geographies across 3 business lines). A Harvard alumni and an ex-Bain consultant, Mr. Gambhir set up Bain’s FMCG consulting practice in India and let it for a time before joining GCPL. His experience in this sector brings a lot to the table.
  • Equally good is Ms. Nibha, who is educated from Wharton and Harvard. She played an important role in getting GCPL out of India and in to the experiments in several global pockets, which have since paid off handsomely for the company. She is also the people leader at GCPL, keen on identifying and developing the future talent of the company. It also shows in the fact that the company was rated #1 in ‘Best Places to Work’ (FMCG Sector). 
  • Of course, the company also has Heads for different regions, all of whom are very capable in their own right.

Weaknesses

  1. The household repellents and insecticides business is prone to short term cycles based on seasons. The company has very little control over the demand situation in this space.
  2. Some of the countries in which the company operates in, like Africa and Latin America are highly unorganized. It is difficult for the company to establish a foothold in the absence of good corporate regulations and a large, unorganized competition.
  3. Given the wide reach of the company’s operations, the need for constantly developing internal leadership is very important. Along similar lines, attrition to competition is also a common problem in the FMCG business.

Opportunities

  1. A whole swath of the company’s offerings (More prominently in the hair care space) are under-penetrated sectors in India, Indonesia and Africa. Although the market size is limited as of today, the future opportunities in the segment are commensurate.
  2. The company has been producing a lot of free cash flows, so there’s ample scope for debt repayment.

Threats

  1. In the age of e-commerce, brick & mortar players are forced to digitalise their portfolios. Laggards may be easily swept under the rug.
  2. Since the company operates in several geographies (90 countries to be precise), currency risk is always a problem. In fact, currency risk is doubly effective, since the company also holds some foreign currency debt.

Strategy Analysis – TOWS Matrix

Maxi-Maxi Strategy (Using Strengths to Maximize Opportunities)

The company has been constantly introducing new products in new regions of Indonesia, Argentina and sub-Saharan Africa, thanks to their culture of innovation. This plays right into the opportunities present in those segments. New product launches grow at a higher rate (25-35%) compared to the existing product lines.

On the capital allocation front, there is a red flag. During FY 2010-11, the company made a string of acquisitions fueled by overseas debt. Regardless of the management’s reasoning at the time, it’s apparent that the additional debt has permanently dented the company’s Return on Capital profile.

After almost 8 years later, the company has planned to reduce this unnecessary debt on their balance sheet, using the ample free cash flows the company generates from its business.

Maxi-Mini Strategy (Using Strengths to minimize Weaknesses)

Although the company cannot control the cyclical nature of some of its product lines, they are adept and controlling costs. For instance, the company’s Operating Margins were at a low ~16% around 2014-15. Project Pi, which was implemented by the CEO in 2014 has substantially improved the margins of the company.

Mini-Max Strategy (Taking advantage of Opportunities to minimize Weaknesses)

Cross-pollination of products across geographies will help reduce the effect of demand cycles in some of the important products lines. GCPL has already been putting in efforts to do the same (For instance, introducing Aer to Indonesia).

Mini-Mini Strategy (Minimizing Weaknesses and avoiding Threats)

The company has been making meaningful investments towards digitalization and data analytics for many of their products lines. CintholForMen is aimed at customer retention, whereas BBlunt is an already fully-integrated online offering. Similar efforts are also being made in other geographies.

The company aims to reduce its foreign currency borrowings. This will not only improve the company’s capital allocation position, but also reduce their currency / translation risk.

Strategy Analysis – Tactics

Tactics, often short term in nature, build up to the overall organizational strategy of a company. Currently, GCPL has the following tactics running for several of its product lines:

The Industry

Right off the bat, something that has be noted about many of the segments that GCPL operates in is that the opportunity size in almost all of them is extremely big (Especially in the Soaps and Haircare segments). The following is a chart representing the opportunity size in India alone:

Rural demand in both India and Indonesia (Key markets for GCPL) is expected to pick up well.

Also Read on FinMedium:  Why David can’t get the better of Goliath this time. (bunder vs kingfisher) – Big Investor Blog

The other big chunk, the hair care segment, has also seen enough traction in recent times:

However, not everything is perfect for FMCG companies. Crude Oil is a key ingredient in a FMCG’s value chain, since it unanimously dictates the distribution costs of these companies. Of late, Oil prices, which had contracted a while back, have started increasing again.

The Numbers

The numbers have been taken from GCPL’s latest Annual Report and Quarterly Reports, all of which can be found here.

Note: Number of Shares

GCPL issued a 1:2 Bonus effective from September 12, 2018. This valuation is done including the new bonus shares.

Note: Risk-free Rate

The current 30-yr GOI Bond Yield (Which I consider the true Risk-free Rate for India) is trading around 7.633%

Note: Company Beta and Indexed Returns

GCPL’s Beta (5-year) and the CAGR of NIFTY 50 (5-year) have been calculated using the help of Yahoo! Finance data sets.

Note: Industry Beta and Industry D/E

Note: Minority Interest

As expected, GCPL holds a number of subsidiaries spanning different nations. However, a handful of them are not completely held. Therefore, the interest GCPL does not hold in them should be removed from the final value.

Since these absolute sizes of these companies are very negligible, I used P/BV ratios accordingly my generic knowledge about each business to value these companies. To this extent, exercise caution, because this may not be really accurate.

The Capital Conversions

Advertisement & Sales Promotion Expenditure

As mentioned in my GSK-CH Valuation, FMCG companies often spend a chunk of their Revenues every year on Advertisement and Sales Promotion activities. These spends usually have a long term impact on the company. As such, they should ideally be capitalized and amortized over a period and not expended in a single year.

Debt and Operating Lease

GCPL’s Debt and Operating Lease is also being converted to their Fair Values.

Notice how GCPL’s Market Value of Debt is actually lower than the Book Value of Debt. We saw a similar thing happen in the Motherson Sumi Systems Valuation. This is happening because most of GCPL’s debt is denominated in the USD and carries a lower interest rate (Than what they’d be expected to pay if they issued Corporate Bonds in India).

Equity Options

GCPL does not have any Equity Options issued to its employees, but it does have a bunch of them issued to the top management of the company:

The average strike price of these options are at ~Rs. 934, way above the CMP of Rs. 670.60. Since most of these options are maturing within 2 years, their Present Value is close to nothing.

The Assumptions

Based on all the discussion we had regarding GCPL and the wider FMCG industry, this is how I think GCPL’s numbers will evolve in the future:

High Growth Period

FMCG companies usually have a very long Competitive Advantage Period. Even keeping that aside, GCPL has a stellar management at the helm. The management’s capability alone will enable GCPL to stay competitive for years and years to come.

Sales Growth

Since GCPL operates in several geographies, it is only logical to separate the Sales Growth estimates accordingly. The ‘Expected Growth’ figures have been obtained from several sources online and some of them even from the Concall summaries.

I have weighted the ‘Expected Growth’ with GCPL’s revenue split against the different regions it operates in. This will make up for a decent baseline estimate for Sales Growth.

Operating Margin

I have assumed that in the initial years, increase in input costs will slightly dent Operating Margins. Since GCPL focuses a lot of cost control (Remember Operation Pi), I am sure they can reclaim their Margins, just like they did in the last 5 years. Post this, GCPL’s Operating Margins will converge towards their own long term average. The FMCG industry’s long term average OPM is actually higher than GCPL’s long term average OPM. But as GCPL evolves, it will become less of a FMCG, since their portfolio will have equal weights in hair care products too.

Tax Rate

GCPL operates in other countries too, and hence, enjoys tax benefits from them (For instance, they got a good tax break from Africa just for setting up business there). However, in the long term, their Corporate Tax Rate will converge towards the Global Average Tax Rate.

Capital Turnover

I have made a big assumption here and that too on the word of the management. I am assuming that the management will indeed reduce Debt as they grow. This will reduce the Capital base and of course then, the Capital Turnover will increase (i.e. Lower Capital base can be recycled faster).

Depreciation

Depreciation will remain fairly stable.

Cost of Capital

The discounting is being done at the Industry Beta-based Capital Asset Pricing Model (CAPM) Cost of Capital.

If you think something is funky with some of these numbers, then you would be right. I have made adjustments in some of these assumptions to account for the Amortization of Advertisement & Sales Promotion Expenditure. For more details on how this impacts the cash flows of a company, refer to my GSK-CH Valuation one more time.

The Diagnostics

No red flag here. Let us proceed.

The Cash Flows

This is how the cash flows of GCPL will evolve based on our assumptions.

Put another way, this is how GCPL’s Business Life Cycle will look like:

We’ve reached the final step in this valuation process.

The Value

I believe Godrej Consumer Products Limited can be valued as below:

I think GCPL is fairly valued at Rs. 532, indicating a ~20.64% overvaluation.

Now, let me assure you that this valuation is not exact. Well, no valuation is, as I always admit. But more so for a FMCG firm, because it is often too difficult to judge just how long the firm’s Competitive Advantage Period (CAP) will last. I cap mine at 20 years usually, but there are clearly several FMCG firms out there that have had way longer CAPs (HUL comes to mind). I cannot modify my model to fit for an increased CAP, but there are a few alternatives:

1. I can claim no Margin of Safety. After all, FMCG companies are the most stable firms out there, as far as profit generation is concerned. If the assumptions are reasonable (Which I think is true in this case), then you can waiver the MoS requirements without much to fear. If I do not claim the meager 5% Margin of Safety on GCPL, the fair value would of course be Rs. 560 instead, indicative of a ~16.46% overvalution.

2. I can increase the Terminal Growth Rate to the upper limit of 7.63% (The Risk-free Rate). At this level and no Margin of Safety, the value is Rs. 684.36 (Try it for yourself, I’ll leave a link to the model below), which is indicative of a fair valuation or a negligible, ~2% undervaluation. However, not many companies can grow at the Risk-free Rate forever (Yes, forever, that’s what the phrase Terminal Growth indicates).

3. I can approximate the value by saying, “It’s most definitely undervalued at around Rs. 550 levels, maybe undervalued at Rs. 600 levels and definitely overvalued beyond Rs. 680.” Interestingly, ~Rs. 600 is around the average of the values Rs. 532 and Rs. 684 (Rs. 608 to be exact).

Honestly, in tricky situations like this, I settle for the last option. Remember, valuations are not an exact science. They are only an indication. Ultimately, you have to interpret it the way you think is the best. If I had to buy GCPL for myself, I would wait for at least Rs. 600 levels and happily average down if it goes below that level. But that’s just me. You should form your own opinion on my valuation.

The Model

You can download the model and give it a whirl if you think I’ve missed something important. If I have, please let me know in the comments section below.

Share of Mind

Warren Buffett is an ardent admirer of companies that have a Mind Share of its customers. Read that sentence again. It is Mind Share, not Market Share that matters according to the Oracle of Omaha. He happened to explain it once with the example of Disney:

Think of Disney. Disney is selling Home Videos for $16.95 or $18.95 or whatever. All over the world—people, and we will speak particularly about Mothers in this case, have something in their mind about Disney. Everyone in this room, when you say Disney, has something in their mind about Disney. When I say Universal Pictures, if I say 20th Century Fox, you don’t have anything special in your mind. Now if I say Disney, you have something special in your mind. That is true around the world. Now picture yourself with a couple of young kids, whom you want to put away for a couple of hours every day and get some peace of mind. You know if you get one video, they will watch it twenty times. So you go to the video store or wherever to buy the video. Are you going to sit there and premier 10 different videos and watch them each for an hour and a half to decide which one your kid should watch? No. Let’s say there is one there for $16.95 and the Disney one for $17.95—you know if you take the Disney video that you are going to be OK. So you buy it. You don’t have to make a quality decision on something you don’t want to spend the time to do. So you can get a little bit more money if you are Disney and you will sell a lot more videos. It makes it a wonderful business. It makes it very tough for the other guy.

Warren Buffett, Florida Business School, 1998.

Also Read on FinMedium:  Art of Investing by - Sajal Kapoor

Now think about Godrej Consumer Products Limited in this context. Well, not the company itself. Think about its products. Imagine yourself in a convenience store, looking for a soap and you find Cinthol on the nearest shelf. Imagine yourself in a local store looking for a mosquito repellent and you find the latest model of Good Knight. Do you find yourself buying these products without comparing the prices with some other competitor? What does your decision tell you about the company?



Source link

Every Wednesday and Saturday, we send Info-Graphic and FinMedium Weekly Digest newsletters to our 25000+ Subscribers.

Join Them Now!

Please Share :)
Dinesh Sairam
Dinesh: Investor | Risk Consultant | Finance Geek | Writer @Quora | Blogger | Poet | MBA from XIME
Back To Top