Godrej Consumer Products, an overview

Qualitative analysis of Godrej:

Godrej consumer products is a part of the Godrej Group with significant presence and
holdings in Asia, Latin America and Africa. It’s business is spread across three major
categories personal care, hair care and home care. It employs more than 21000 personnel
worldwide and is a leading name in the Fast Moving Consumer Goods Segment in India.
The mission - to uphold the Godrej Brand and corporate image of reliability and integrity.
The Vision - to globalise business rapidly both and enrich the quality of life everywhere
Objective - to delight customers both in India and abroad.

Industry Analysis:

Godrej Consumer Products Ltd. ( termed as GCP henceforth) operates at the intersection of
multiple industries such as hygiene, grooming and skincare industries. It also operates in
multiple geographical locations either alone or with the help of a local partner.
Below is an objective analysis of the industry using Porter’ Five Force Model:

Threat of new entrants: MODERATE

1. The entry barriers are low, several small startups have entered the market that
produce similar products in grooming and hygiene and skincare. The skincare industry
has a slightly higher barrier than the rest as the products need to be approved by the
FDA.
2. The amount of investment required to enter the market is low.
3. It is difficult to create a supply chain to compete with the margins of the
established players. GCP has another advantage as it owns it’s supply chain and
infact it also
supplies raw materials to it’s competitiors like L’oreal.
4. The industry already has a lot of established players with a loyal consumer base.

Threat of substitute: HIGH

1. Lot of companies in the market produce almost similar products.
2. GCP faces competition from multiple companies due to the product portfolio
belonging to multiple industries.
3. There is not much of a difference in the price of similar products so there is negligiable
switching cost.
4. Substitutes are of similar quality in a similar price range.

Rivalry among competitors MODERATE

1. High concentration of competiting products that are targeted to a similar consumer
base.
2. High growth of the industry due to increase in the purchasing power of consumers
in developing countries allows for both coexistance and competition.
3. Due to economies of scale large companies(like GCP) enjoy higher margin and brand
reputation essentialy ignoring the competition by smaller companies.
4. Higher competiton among large companies due to similar pricing of products.

Bargaining power of buyers: HIGH

1. Due to similar products being offered by competition the buyer have a lot of choice for
the same product.
2. The switching cost is very small due to similar pricing of products.
3. Buyers are price sensitive as they can easily switch to a cheaper alternative without
any significant change in the quality of the product.

Bargaining power of suppliers:LOW

1. Most large companies own whole or part of their supply chain.
2. Due to the presence of multiple firms in the industry the suppliers might have other
alternatives but due to similar pricing and similar margins in the industry the suppliers
bargaining powers are limited.
3. Suppliers have small switching costs due to similar business models of other companies
in the industry.
4. Suppliers might have exclusive contracts with firms extending to multiple years in
the future.

Competitive Strategy Analysis:

Competitive Advantage:
Strong brand reputation: Belonging to the Godrej Group with a legacy of over 123 years
provides GCP a unique position in the market. The Godrej Group has a great reputation with
customers and suppliers alike. Several of GCP products are a household name in India with a
strong portfolio of brands for example Cinthol, Good Knight, HIT, aier, ezee etc.

Owning their own supply chain: GCP obtains most of it’s raw materials through Godrej
Industries(Chemicals) in effect owning part of it’s own supply chain of raw materials. This
gives them an edge over their competition that has to obtain their raw materials from third
parties. Due to being in FMCG industry most of the sales are done from third party shops thus
allowing greater margin on those sales.

Well defined consumer base: GCP has a well defined consumer base consisting largely of
the emerging middle class in developing countries. Due to significant presecnce in Asia,
Africa and Latin America, GCP has positioned itself so that it is able to take advantage of the
growing income and purchasing power of people both locally in India and internationally.

Diffrentiation Strategy:
Strong R&D: GCP aims to obtain an edge over the competition by introducing innovative
products in the market. For e.g. GCP launched the worlds first Powder-to-liquid hand wash
for a marginally low price of 15 INR(0.20 USD). It also introduced the 1 INR insecticide in
India. GCP developed and introduced the first sachet hair color creme in Latin America and
hair braids for African hair.

Multi-industry exposure: GCP has products in multiple industries like health, hygiene,
skincare, grooming, babycare etc. This allows GCP to obtain a larger consumer base to
which it can offer other products from it’s portfolio. But this also means GCP faces
competiton from firms in multiple industries.

Corporate Strategy Analysis:

Extending leadership in multiple industries and geographies and tapping into the emerging
markets to obatain bigger consumer base. Strategical expansion into developing countries
to obatin less compition and stronghold future growth. These places will power the Global
consumption in the coming decades.

Enhanced long-term value for all stakeholders, including shareholders, customers,

consumers, suppliers, distributors, retailers, and the community. Reinvestment of equity
profits into assets and brands to improve their intrinsic value and boost future revenue.

Diversification into mutiple Fast Moving Consumer Goods to allow for a wider catelouge of
products to offer thus increasing potential customers.

Investment in R&D to produce innovative products that capture the popular imagination
while maintaining competitive pricing. Also identifying and obtaining unique
consumer insights though advanced predictive analytics.

Investing in Nature capital by sourcing investments in renewable raw materials, reducing

freshwater use and waste emission to water bodies and landfills. Investment in green
initiatives.
 ROE decomposition:

Due to the following shortcomings of the traditional approach to ROE decomposition, I’ll be
using the alternative approach:
1. In the traditonal approach the assets are claimed by all the capital providers of the
firm but the earning used is only available to the equity shareholders. GCP finances its
working capital from both debt and equity so using the traditional approach will give
incomplete
information.
2. The assets include not only the operational assets but financial assets as well as
short term marketable securities and cash.
3. Firm’s cash and marketable securities are not recognized as negetive debt in
the traditional approach.
4. Net income includes both operating income and intrest income/expense

GCP Alternate ROE decomposition (all figures in INR Crore):

Calculating the Tax rate:

Profit before tax = 1399.63 Current tax expense = 248.20
Tax Rate= 1399.63/248.20 *100 = 17.733%

Calculating Net interest expense after tax:

Interest Expense = 217.41 Interest income =112.30
interest expense after tax = (212.41 - 112.30)*(1-0.17733) = 86.474

Calculating NOPAT:
NOPAT = Net income + Net Interest expense after tax
Net income = 1179.89
NOPAT = 1179.89 + 86.474 = 1266.364

Calculating Operating working capital:

Current assets = 2061.36 Cash and cash equivalents= 63.76 Bank balances = 21.92
Current liabilities= 1724.26 Short-term debt = 317.33 lease liabilities =
3.48 Total outstanding dues of creditors(Trade Payables) = 1215.99

Operating Working capital = (2061.36 - 63.76 - 21.92) - (1724.26 - 317.33 - 1215.99 - 3.48)
= 1788.22

** Notes :
● Bank Balance has been considered as cash equivalent as this can be liquidated with
ease.
● Lease liabilites are considered as short-term debt
● Total outstanding dues of creditors(includes both vendors and banks) is consider the
current portion of long term debt due this year.
● Trade Payables considered short term debt.
● The investments line item contained non marketable securities such as Investments in
Non-convertible Debentures with NBFCs also the mutual funds line item was empty
also there was no line item for stocks and bonds so the marketable securities was not
considered in calculation.

Calculation of Net long-term assets:

Total long term assets = 4879.23 Non-interest- bearing long-term liabilities= 43.2
Net long-term assets = 4836.03

**Notes:
● In the calculation of the Non-interest- bearing long-term liabilities, in the non current
section of the balance sheet of GCP contained financial liabilites(interest bearing),
lease liability(interest bearing), unearned revenue(non interest bearing) and Deferred
Tax. It also contained defered grants and sundry deposits but due to the lack of
information and small value they were not included.
Calculation of net debt:
The following items were considered in the calculation of Total interest bearing
liabilities: Non- current lease= 4.94 Non-current Gratuity=
56.63 current lease= 3.48 Borrowings= 317.33

Total interest-bearing liabilities = 382.38

Cash and marketable securities = 85.68
Net debt = 382.38 - 85.68 = 296.7

Calculation of net assets:

Net assets = 4836.03 + 1788.22 = 6624.25

Calculation of Shareholder’s Equity:

Shareholder’s Equity = Total assets - Total liabilities
= 6940.59 - 1812.97 = 5127.62

Calculation of Net Capital:

Net Capital = 296.7+5127.62 = 5424.32

Roe calculation:
NOPAT/net assets *(1+ net debt/equity) - net interest expense after tax/net debt * net
debt/equity
ROE=((1266.364/6624.25)*(1+ 296.7/5127.62) - 86.474/5127.62)*100
ROE= 18.536%

ROE values on major economic websites:

Economic times 19.76%
Bloomberg Quint 18.13%
Financial Express 18.94%
Value research 18.46%

The calculated values are summarized in the table below

Net interest expense after tax 86.474

Operating working capital 1788.22
Net long-term assets 4836.03
net debt 296.7
net assets 5424.32
NOPAT 1266.364
Tax Rate 17.733%

The ROE of GCP as we found out is 18.536%. To find if this is acceptable and to determine if
the comapny is using the equity efficiently we compare it to the average roe of the Fast
Moving Consumer Goods (FMCG) industry.
According to The Economic times, the peer companies of GCP had an average ROE of 19.01%
(Source). Thus we can conclude the performance is satisfactory when compared to it’s peers.
But we can see slight decline from the historical average of 25.38%(source), this can be in
part due to the fact that the firm is expanding rapidly across the emerging Nations and is
reinvesting quite a bit of its returns to fund it’s expansion.
Valuation:

Beta Calculation:

Using bottom-up beta approach:

I took the betas , debt/equity ratios of comparable firms to arrive at the average unlevered
beta

Company Beta Debt/Equity Tax rate

Hindustan Unilever 0.612 0.00 25.17
Nestle 0.95 0.03 25.2
ITC 0.74 0.01 20
Britannia Industries 0.62 0.28 18
Dabur India 0.71 0.13 18.22
Marico Ltd 0.50 0.11 22.6
Colgate Palmolive 0.38 0.21 17.32
Gillitte India 0.31 0.00 26.32
Bajaj Consumer Care 0.853 0.12 19.08

Average Industry Beta = 0.630

Average Industry Debt/Equity = 0.0988
Average Industry Tax rate = 21.32%

Unlevered industry beta = 0.630/(1+(1-0.2132)*0.0988) = 0.5845

Tax Rate of GCP = 17.733%
Debt/equity of GCP = 382.38/5127.62 = 0.07457

Levered Beta of GCP = 0.5845*(1+(1-0.17733)*0.07457) = 0.620

Risk Free Rate Calculation :

Return on a 10 year government bond in India = 5.881% (source)

Credit rating of India Baa3 (source) , the associated default spread = 2.58%
Risk free rate for India = 5.881%-2.58% = 3.301%

Risk Premium Calculation :

I will be using the Historic Stock market returns to calculate the risk premium. As the beta is
0.62 the correlation between the market and the firm is not very strong so I’ll be using the
Arithmetic average to obtain the unbiased estimate.

Year Stock market return

(NIFTY)
2015 -4.1%
2016 3.0%
2017 28.6%
2018 3.2%
2019 12.0%
Average 8.54%

The Risk premium from this approach comes out to be 8.54%-3.301% = 5.239%
Cost of equity :

Using the Capital Asset Pricing Model :

Cost of equity = 3.301 + 0.620*5.239
= 6.55%

Cost of debt :

Interest Coverage Ratio of GCP(as per the annual report) = 8.75

The associated rating is A+ and the default spread is 0.7%
Cost of debt = (3.301 + 0.7)*(1-0.17733) = 3.291 %

Cost of Capital :

Total debt/Equity = 296.7/5127.62 = 0.0578

Cost of capital = 0.0578*3.291 + 0.9421*6.55 = 6.36%

ROCE:

EBIT(1-tax)= 2098.2*(1-0.1773) = 1726.189

Book value of debt = 296.7
Book value of equity = 5127.62
ROCE = 1726.189/(5127.62 +296.7)*100 = 31.82%

Reinvestment Rate:

Capex = 174.71 (from annual report)

Change in non-cash working capital = 572.36 (from annual report)
Depreciation = 81.37 (from annual report)
Reinvestment rate= (174.71+572.36-81.37 )/1726.189 = 38.56%

Growth Rate :
Growth rate during growth phase = 0.3182*0.3856*100 = 12.27%

Stable Period Calculations:

Stable period growth rate is assumed to be equal to the risk free rate = 3.301%
Stable period reinvestment rate = 3.301/6.36*100 = 51.90%

DCF of GCP:

The two stage FCFF model is used for the following valuation. Also the growth period has
been assumed to be 10 years .The reasons for the following are:
● The levergae of the firm has been unstable over the years.
● The firm has recently taken up debt thus FCFF is a more appropriate model to account
for this change.
● The firm has recently stopped giving dividend as is reinvesting the profit has the
dividend discount model is ruled out.
● The firm is comparatively young (Estd 2001) and it has been expanding into new
markets such as Latin America, Africa and Indonesia, thus the assumption has been
made that the firm will keep on growing for at least another 10 years before entering
into the stable growth period.
● The firm has the backing and goodwill of Godrej group and thus it is assumed that it
will not have any problem obtaining debt or equity, hence the same cost of capital is
assumed for the 10 year growth period.

Calculations:
EBIT=2098.2 tax rate= 17.73% capex= 174.71 D&A = 81.37 discount rate= 6.36%
EBIT(1-t) = 1726.189
 FCFF = 2098.2(1-0.1773) - (174.71-81.37)= 1632.849

The FCFF for current period comes out to be 1632.849. Assuming that the free cash flow
grows at the growth rate calculated before, the corresponding future cash flows are
calculated by multiplying the cashflow with the growth rate.

Year 1 2 3 4 5 6 7 8 9 10
Growth rate% 12.27 12.27 12.27 12.27 12.27 12.27 12.27 12.27 12.27 12.27

Free Cash flow 1833.19 2058.133 2310.66 2594.18 2912.49 3269.85 3671.06 4121.50 4627.21 5194.97

Cost of capital% 6.36 6.36 6.36 6.36 6.36 6.36 6.36 6.36 6.36 6.36

Present value of cash 1723.57 1819.23 1920.441 2027.15 2139.79 2258.18 2384.20 2516.66 2656.52 2804.14
flow

The present value of the future free cashflows during the growth phase= 22249.311

Terminal Value:

The terminal value of the firm of the firm is calculated by:

{EBITn+1(1-t)(1-Reinvestment rate)} ÷ (WACCn – stable gowth rate}.
In the calculation of EBITn+1 the assumption is made that the EBIT will grow at the
calculated growth rate of 12.27%. Using this assumption EBITn+1=EBIT1*(1+g)^10*(1+stable
g) EBITn+1= 5673.21
The Terminal Value = 5673.21*(1-0.1773)*(1-0.519)/(0.0636-0.03301) = 73389.84
The present value of the Terminal value = 39614.47

Total Present Value of GCP:

The net value = 39614.47+22249.31= 61863.78

Share Value:

Shares outstanding= 102.216 crore

Value of share(in INR) = 61863.78/102.216 = 605.226

Recommendation(Buy/Sell):

GCP share has been trading in the range of INR 650-700 in November 2020. According to the
discounted cash flow valuation GCP is overvalued by about 6.88%-13.54%.The stock has also
shown high volatility this year as it went to a 52 week low of about 430 in May, so a more fair
recommendation should factor in the volatility of the stock. As an analyst my
recommendation will be:
● If holding the stock current then sell it.
● If wanting to buy then wait for the stock to come in a reasonable range of value that is
aliigned to it’s fair value.
● Short the stock if a long/short strategy is being considered.

Conclusion

All values and figures have been used from the 2019-20 balance sheet. Any external source
used has been linked in the respect section. Important numerical figures has been written in
bold.