Godrej Consumer Products Ltd’s (GCPL’s) shares rose nearly 2% after it announced March quarter earnings, as if its valuations weren’t too high already. While there were pockets where the company did well, overall the results were a mixed bag. Overall sales were soft, while profit margins were higher-than-expected. The international business, where GCPL has been investing aggressively, continued to drag overall profitability, while the domestic business reported sales and profits in line with expectations.

But importantly, note that the company has ended up with earnings growth of 12% in FY18, falling short of growth expectations of around 20% at the beginning of the year. “Positive narrative will likely mean the Street ignores disappointing delivery once again," analysts at Kotak Institutional Equities wrote in a note to clients. Investors are hoping that an expected recovery in rural demand will revive growth rates in coming years. But valuations of well over 40 times earnings are pricing all this and more.

The performance of the domestic business mirrored GCPL’s optimism in India’s consumption story. Soaps, which account for 31% of domestic sales, clocked the best growth among various segments, at 19% year-on-year.

But on the other hand, the 5% decline in sales in household insecticides, the company’s largest business segment, was disappointing. In a call with analysts, GCPL’s management brushed this aside as a seasonal issue, adding that sales in March and April were better. Another reason that weighed down revenue was the low 3% sales growth in hair dyes due to stocking up of sales channels after the goods and services tax-led price cuts.

In the international business, the company is still struggling with challenges. Barring Indonesia, growth in market share and revenue in other regions such as Latin America, Africa, the US and Middle East came at the cost of margins. Product launches and market penetration have led to significant promotion expenses that weighed on profits. Operating margin in the international business, therefore, contracted by 110 basis points (bps) year-on-year.

A silver lining was the 150bps improvement in consolidated operating margin to 24.3%. Reported margins were also 100bps higher than Bloomberg’s consensus estimates. But investors may do well to note that higher margins came on the back of lower derivatives cover and related losses on its palm oil purchases. Consequently, a 370bps jump in the domestic operating margin gave a leg-up to overall profitability in spite of a moderate 4% rise in consolidated net sales during the quarter.

That said, GCPL trades at a rich valuation of 42 times earnings estimated for FY19 by the Street. Indeed, in the fast-moving consumer goods business where size does matter to capture the market, the company has a stronghold ranking among the top three players across its product segments. Although this would support valuations, any stumbling blocks in the international business that also comprises nearly half the consolidated revenue, may puncture the euphoric rally in the stock.

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