Performance Highlights

- Steady Top-line growth, up 21%: For 1QFY2010, Godrej Consumer Products (GCPL) posted a steady Top-line growth of 21.4% yoy, on a consolidated basis, to Rs438.9cr (Rs361.6cr), significantly ahead of our expectations of a 10% yoy growth to Rs398cr, driven by robust performance across divisions. Soaps posted a strong 27%, growth aided by market share gains (benefiting from down-trading), increasing focus on smaller packs (to drive rural penetration) and a successful varianting strategy. The Hair Colour Division posted a modest growth of 20% yoy, on a standalone basis, aided by an 180bp jump in the qoq market share to 34.4% (32.6%). The performance of the International business registered impressive gains during the quarter, with Keyline Brands (UK) registering a modest growth in revenues by 9% and 18% in Rupee and British Pound terms, respectively. Rapidol (South Africa) posted a growth of 11% in local currency (ZAR) terms, whereas revenues in INR terms grew a strong 20% yoy. Kinky posted a growth of 50% yoy in revenues to Rs16.2cr for the quarter.

- Earnings surprise, grow a whopping 78%: GCPL’s consolidated Earnings for the quarter registered a whopping growth of 78.2% yoy to Rs69.7cr (Rs39.1cr), ahead of our expectation of a 49.7% yoy growth to Rs58.5cr. The higher-than-anticipated Earnings growth was aided by a sharp Margin expansion and marginally lower depreciation charges and interest costs. Tax Rate for the quarter was higher by 76bp on account of a higher MAT rate on the domestic operations.

- Margins leap back to historical levels, expand 598bp: At the operating front, GCPL delivered one of its strongest performances, registering a sharp Margin expansion of 598bp to 19.7% (13.7%), driving a whopping 74.3% yoy growth in EBITDA to Rs86.4cr (Rs49.6cr). An 865bp jump in Gross Margins (owing to a sharp fall in Palm oil prices) was the key driver behind the Margin expansion. However, higher advertising spends (up 38bp yoy) and rise in staff costs (up 236bp yoy) limited further Margin expansion. Going ahead, we believe that GCPL will continue to post better Margins as Raw Material cost pressures have declined significantly.

Segment-wise Performance

Soaps: GCPL’s Soaps business continues to be the major revenue contributor, constituting 69% (on a standalone basis) of the branded sales mix. The division clocked its highest ever sales, posting a strong growth of 27% yoy on a standalone basis to Rs233.2cr (Rs183.3cr), partially aided by market share gains (benefiting from down-trading), increasing focus on smaller packs (to drive rural penetration) and successful varianting strategy. GCPL launched two new variants, ‘lime’ and ‘aloe’ under its Godrej No1 brand during the quarter. The company continued to be the second largest toilet soaps player in India, increasing its market share to 9.8% from 9.4% in 4QFY2009 (market share had increased to 10.1% in June 2009).

Hair Colour: GCPL’s Hair Colour business posted a modest growth of 20% yoy to Rs74.8cr from Rs62.2cr on a standalone basis, aided by an 180bp jump in its qoq market share to 34.4% (32.6%). The market share has increased to 34.8% in June 2009. We believe GCPL’s increased focus on this division, in terms of higher retailer margins and new variant launches (Godrej Expert Hair Colour in Powder and Liquid form), has started yielding positive results. During the quarter, the company re-launched Godrej Nupur Mehendi in a new and improved formulation.

International Business: International business registered impressive gains during the quarter, contributing around 21% to the overall Top-line. Keyline Brands (UK) registered a modest growth in revenues by 9% and 18% in Rupee and British Pound terms, respectively, despite the recession in the UK economy. Rapidol (South Africa) posted a growth of 11% in local currency (ZAR), whereas revenues in INR terms grew a strong 20% yoy. Kinky posted a growth of 50% yoy in revenues to Rs16.2cr for the quarter. Kinky opened two new stores during the quarter, taking the total tally of stores to 24.

Merger to acquire 49% stake in Godrej Sara Lee (GSL)

During the quarter, Godrej Consumer Products (GCPL) proposed a merger of Godrej Consumer Biz Private Limited (GCBPL) and Godrej Hygiene Care Private Limited (GHCPL) into GCPL, to be funded through a share-swap deal. Through the merger of these two entities, GCPL will indirectly hold a 49% stake in Godrej Sara Lee (GSL), which is a 49:51 unlisted joint venture between the Godrej Group and the Sara Lee Corporation, USA. GSL is the market leader in household insecticides. The merger will lead to equity dilution of 20% for GCPL, but will be EPS accretive.

We believe that the merger of both these entities into GCPL will address the key issue of sustainable growth drivers for GCPL, as it will widen the company’s FMCG portfolio and give it better bargaining power in terms of distribution. Moreover, the merger will put the Godrej group on a stronger footing to buyout Sara Lee's 51% stake in Godrej Sara Lee, if the situation arises in the future. We believe that any developments on the acquisition of Sara Lee’s stake (at similar valuations as acquired from Group companies) carry upside risks to our estimates.

Outlook and Valuation

We are extremely enthused with the 1QFY2010 results on two counts - 1) Steady Top-line growth contributed by modest performance across divisions, both domestic and international business are faring well, and 2) higher-than-anticipated Gross Margin expansion, indicating the end of the high Palm oil price overhang on GCPL’s valuations. Hence, we have tweaked our Top-line and Earnings estimates to factor in the same. We have also included the effect of the Godrej Sara Lee (GSL) acquisition (from 2QFY2010), modeling in a 20% dilution and the addition of the proportionate share of profits into GCPL’s numbers to the tune of Rs46cr and Rs70cr for FY2010E and FY2011E, respectively, as a share of profit from associates.

We expect GCPL to witness a slight moderation in its Top-line growth over FY2009-11E, owing to high base (Kinky consolidated effect and strong growth in Soaps). Nonetheless, a renewed performance of its Hair colour division (aided by product re-launches and strong marketing support), along with steady growth in its Soaps division, should help GCPL register a CAGR of 14.8% yoy in Revenues over FY2009-11E. At the operating front, we expect GCPL’s margins to expand 421bp during FY2009-11E, largely on account of softening input costs. In terms of Earnings, we expect GCPL to post a strong 26.3% CAGR in its Bottom-line (post-dilution) during the period FY2009-11E, driven by higher Interest Income (due to surplus cash from rights issue), Margin expansion and inclusion of GSL’s profits.

Post acquisition of GSL, we had indicated that the widening of its FMCG portfolio coupled with a higher Bottom-line is likely to lead to re-rating of the stock on the bourses. The significant outperformance by the stock of 21% vis-à-vis Sensex during the past 3 months vindicates our stance. We believe that GCPL will continue to benefit from a benign input cost environment over FY2010E. Moreover, upsides from GSL’s consolidation can give further fillip to the stock. Hence, we recommend Accumulate on the stock, with a revised Target Price of Rs227 (Rs212) based on 21x FY2011E FDEPS of Rs10.8.