Is the December quarter an aberration or is Godrej Consumer Products Ltd seeing a structural shift in profitability? Investors were prepared for some impact on margins, on the back of an increase in advertising and promotion (A&P) spends. However, a declining trend in input cost inflation gave them comfort that it could spend more without adversely hit margins.
Against this backdrop, a 3.2 percentage point drop in Godrej’s operating profit margin in the December quarter, versus the year ago period, is a rather unpleasant surprise. Godrej’s advertising and promotion spends rose by a high of 61%—they had increased by 40% year-on-year in the September quarter.
Of course, the hike in advertising has helped the company maintain robust revenue growth–it reported a 25.7% growth in sales to Rs.1,695.6 crore, while organic growth (excluding the impact of acquisitions) was 19%. This growth in sales was accompanied by only a 19.2% increase in the cost of goods sold, giving it ample headroom to grow margins. But not only did A&P spends increase significantly, employee costs and other expenses too rose much ahead of sales growth.
The net impact was that its operating profit rose by only 5.8%, and a higher effective tax rate meant that its net profit (after minority interests) rose by only 3.1%. That is far from exciting, and especially low, given the rate at which the company is growing revenues.
The pertinent question is whether this is only temporary. A&P spends have increased to support new launches across categories and geographies. This is also visible in a sharp increase in inventory during the quarter, compared to year ago and sequential figures. Thus, the benefits of higher A&P spends may be spread over a longer period. And if sales growth steps up in subsequent quarters, A&P as a percentage of sales can moderate from current levels. Also, if the impact of declining raw material prices, such as that of palm oil intermediates, is reflected fully in subsequent quarters, gross margins may improve further, widening the headroom available to meet costs.
On the business side, in its domestic business, its household insecticides business is doing well, with sales growing by 28%, and growth in hair colours recovering to 17% from 10% in the September quarter.
In soaps, which contributes to a third of standalone sales, value growth is healthy at 20% but volume growth is only 2% against 6% in the September quarter. But margins have improved, according to the company. This was visible in Hindustan Unilever Ltd’s performance too, and it appears that sustained price hikes are affecting demand in price-sensitive categories, especially when cheaper input costs may be giving rise to competition from the unorganised segment.
Its international business remains in good health, though there is a dip in margins, which the company attributes mainly to a base effect in its Africa business, though margins in other regions too declined (but by a smaller extent) over the year ago period. Apart from the soaps business, its business appears to be in good health.
Having said that, the December quarter results have made investors nervous as is visible from the decline in its share price, immediately following the results.