Consumer goods majors Marico and Godrej Consumer Products reported divergent revenue growth trajectories in the quarter gone by. In both cases, margins expanded, with Marico continuing to put up a better operating performance in recent times.
We prefer Marico because of its better financials and convincing moats, particularly in the domestic market.
Q1 FY20 review
– Revenue growth was driven by healthy volumes (6 per cent higher volumes in domestic markets, constant currency growth of 7 per cent in international geographies).
– Gross margin expanded YoY because of lower raw material costs.
– Operating margin rose due to cost efficiencies.
Godrej Consumer Products
– Branded domestic business volume grew by 5 per cent year-on-year (sale of soaps was 3 per cent higher, household insecticides reduced by 4 per cent and hair colour sales were flat YoY).
– On a constant currency basis, international revenue jumped by 9 per cent (excluding the effect of a divestment in Europe).
– Ad spends and staff costs, as percentage of sales, fell from a year ago. However, other expenses rose in comparison, restricting EBITDA margin expansion.
Marico – The path ahead
Parachute volumes grew 9 per cent YoY in Q1 FY20 in spite of a high base. This was on account of market share gains and improved penetration in non-core markets. Offtake for ‘Parachute’ branded oils has been encouraging vis-a-vis most peers. Impetus will be laid on value proposition in a bid to achieve 5-7 per cent volume growth over the medium term.
The management has been investing heavily in setting up traditional distribution channels (ie., brick and mortar stores) and is coming up with new stock keeping units, particularly in the rural market.
In urban areas, weakness in the general trade channel will be offset by healthy offtake seen in modern trade. To reach out to more customers, the FMCG major is eyeing chemist, cosmetics and specialty food outlets.
Subdued growth in urban general trade channels has been tackled to some extent by online sales, which have been on an uptick of late. Therefore, most of the product launches in the personal care section are likely to be done digitally so as to enhance brand recall.
Raw material costs moderating
Copra oil, one of the key inputs for Marico’s hair oil products, has seen a dip in prices lately (25 percent down YoY). This trend is slated to continue in the near future, potentially aiding gross margin expansion.
Implementation of VAT and introduction of new products in Bangladesh (comprising approximately 45-50 percent of this segment’s sales) are key positives.
In Vietnam (constituting nearly 30 percent of exports), the HPC (home and personal care) portfolio is witnessing good traction.
Margin derived from such regions rose sharply to around 24.5 percent in Q1 FY20, but is expected to moderate at close to 20 odd percent. This is because promotional spends are likely to go up in due course with an objective to enter new geographies.
Expansion of foods range
Marico launched ‘Saffola Perfect Nashta’ recently. This is currently sold through modern trade mechanisms and select outlets in Delhi. Subject to customer reception, this brand may be scaled up later.
Edible oil (Saffola) sales were tepid in April-June, growing at only 3 percent YoY. This has been attributable to sluggishness in the urban channels and better recall of its competitors’ offerings.
Non-core hair oil brands (Nihar Naturals and Oil by Malabar) have been facing stiff competition from entities in smaller regions due to steep discounting.
In the premium hair oil (value-added hair oil) category, competition and reduction of discretionary spending by masses is another challenge that will have to be addressed.
In the male grooming segment, demand for deodorants has been weak in India.
Uncertain macroeconomic conditions in the Middle East and Africa (jointly making up 15 percent of international sales) could dent demand.
In our view, Marico should be able to report mid to high single-digit volume growth by the end of this fiscal year because:-
– The company’s core franchises have been gaining market share, thanks to extensive marketing initiatives
– New product developments are high on the agenda and are anticipated to contribute 2 times more to the annual turnover over the next 2 years
– Regional players have been facing liquidity challenges
– Product positioning is improving
– Difficulties faced by wholesalers may moderate in H2 FY20 since monsoon is picking up pace
We believe Marico has what it takes to emerge stronger once the ongoing consumption slowdown shows some signs of recovery. Meanwhile, we find comfort in the company’s strategy of deploying gross margin gains for investment behind brands. At 37.2 times its FY21 projected earnings, the stock, in spite of its steep valuation multiple, is a worthy investment pick from the FMCG stable.
What about Godrej Consumer Products?
We are cautious about the stock because:-
Repellent business (household insecticides) under strain
This segment makes up 35 percent of GCP’s top line. Apart from India, the company’s products are primarily sold in emerging markets.
On both fronts (domestic and international), GCP has been facing stiff competition from local unorganised players.
Since the company’s products are subject to stringent laws on chemical composition, the compliance and manufacturing costs increase correspondingly. Local unorganised entities don’t follow the prescribed rules and also undercut GCP’s prices quite a bit.
Difficulties in Africa
In African markets, the management does not forsee a sharp recovery in margins. This would be on account of continued investments in growth plans and weak economic outlook.
Hair color segment sales are slated to be below expectations because of stiff competition from other premium brands.
In the soaps division, price cuts have been taken by GCP’s peers (HUL, other local names in smaller regions) in the economy category. This would put downward pressure on margins.
Though prospects of a recovery on the above-mentioned fronts cannot be ruled out in the long run, for GCPL, earnings visibility will continue to remain impacted in the near future.