About
GSK consumer is a 1300 Cr consumer goods company with well known brands such as Horlicks, Boost, Maltova, Crocin etc. The company is a part of the Glaxo smithkline group which specialises in pharma products
Financials
The company has done well for the last 5 years after a dip in performance in 2001-2002. The company topline dropped by 12% in 2002 and the bottomline by 33%. The company has since then recovered the topline growth to around 10% per annum and Net profit growth to around 12-15% CAGR.
The RONW/ROCE have improved to 20%+ levels due to improvement in margins and Asset turns. The company has no debt and an approximate cash of 300 Crs.
Positives
The company has strong brands, well established distribution network and a high market share in its category (around 70%). In addition the company has cash of 300 Crs on its balance sheet.
The management has been a rational allocator of capital. They have maintained a dividend payout of almost 35%. In addition the management executed a buyback in 2006 of around 125Crs using up the excess cash. The current cash on the Balance sheet is for acquisitions and to grow the business.
The company plans to introduce 2-3 of its international brands in the couple of years such as sensodyne, breathe right etc.
Risks
This is a single product company. Crocin and Iodex brands are not owned by it. The company only distributes it for the parent and gets a fee for it. As a result topline and bottom line is based on a single product category and it can get hit again as in the past by a drop in the demand or competition or both.
The company has plans to acquire new brands and businesses, but it remains to be seen how that will play out.
In addition it remains to be seen if the Global brands to be introduced in india would be successful or not.
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any accquisition. Those would be icing on the cake, but I would not value them as yet.
conclusion
The company seems to be undervalued by 20-30%. In addition the upside from introducing global brands or any acquisition is not included in the calculation. So that could be a positive upside (or a negative if it fails). I find the investment idea good, but not mouth watering. Would like to wait and watch
Disclaimer : I don’t hold the stock (as yet). In addition I may change my mind at any time on that and may not put that on the blog. So please look at the disclaimer below and take your own decision.
12 comments:
I have looked at the stock in the past and though there is value in the stock, I have a few concerns on the company
Short Term concern
1) The Dec 07 quarter has seen a significant drop in topline which is a worry variable along with the associated drop in the bottomline. I am not able to figure out if there are any products that have been phased out. The concern also stems from a drop in operating margins for the Dec 07 quarter. This is a short term worry variable.
Long Term concern
1) The company has a brilliant cash cow in the form of Horlicks. My concern is that the management hasn’t been unable to leverage that over the years. Most brand extensions like the move into biscuits etc have come to naught. I’ve had similar concerns with HUL where the organisation in the last 5 years hasn’t been able to come up with significant wins and is losing out to ITC. It amazes me that in growth market like India where we are talking about penetrations increases, managements are looking at share buybacks. Its good from the investors standpoint at one level but leaves me worried on the managements ability to ride growth.
2) GSK has a huge moat in the category that it belongs to but my worry variable is the risk that the category itself has from other product categories. Historically milk supplements were the only way that a mother would add nutrients to a childs diet which she felt was inadequate. Today the category itself is at risk from categories like breakfast cereals Kellogs, Quaker oats etc. The kid doesn’t have to drink a glass of milk because he/ she has it with his bowl of cereals.
3) The other concerns is from a player like ITC which could enter a category like this. They have the distribution clout and balance sheet to ride out losses for a long time which could squeeze out the healthy margins that GSK Consumer makes. It might not happen and GSK could still come out winner but you will see a few years of depressed margins when that happens.
Cheers
Ninad
Hi ninad
great comment. i completely agree with your observations. Due to this business risk and competition i do not see as much value as one would think based on the current valuations.
In addition GSK is an MNC and hence constrained by the parent from launching/accquring new brands in india. In addition their new products have not been too successful.
however i find their capital allocation to be rational.
What i am most worried is about competition from stronger players such as ITC who can take losses for years togethers till they can dominate this market.
that could really hurt GSK. HLL in such a position once where they could almost kill competition in any category they entered.
regards
rohit
Hi Rohit
Our honourable finance minister seems to like breakfast cereals over Horlicks with the excise wavier on cereals :-).
On a more serious note i m personally grappling with my thought process on companies like GSK Consumer. There are a lot of MNC pharma companies which look very atttractive value buys. I own stocks in a company called Abbot labs. It owns brands like Brufen, Digene etc. Gives about 3 – 3.5 % dividend yield and does about 5 % share buyback every year. It’s a no brainer in terms of a value stock.
However let me state my concerns. The management again doesn’t know what to do with cash. True they will utilise it efficiently by returning it to the shareholder. The stock will give you returns better than a fixed income instrument. But is there a opportunity cost that one is losing out. In a growth market like India is there a opportunity loss for your capital by parking it with managements who don’t have the aggression/ ability to ride the growth.
A classic example would be the HUL v/s ITC example. Everything is right about HUL - Decent dividend yield, share buyback etc but its ITC which is using the its tobacco business cash cow to expand its FMCG footprint. Still pondering on this.
Also its great that you have this blog. It helps all of us refine our own thought processes by these exchanges.
Ninad
Hi ninad
there are several MNC pharma companies which seem to be selling at a considerable discount to intrinsic value. i think the main reason is that these companies have strong competitive advantages. however they are not able to use the surplus cash in new growth options. as a result the market has beaten down these companies a lot (maybe more than required)
abott, novartis, merck, pfizer all are suffering from the same bias. In the current bull market, there is a lot of premium for growth and if the company is not growing, it is getting wacked.
i would prefer a company which can grow and has strong ROE, but then so does everyone else. the next best are the companies you mention like abott. i would prefer such companies as long as they dont blow away the cash
so you concern is valid. but in absence of opportunity i would prefer if the management did nothing foolish and just returned the cash back to the shareholder.
if there is a bear market, i think such companies will drop less and would be very good bargains
Hi Rohit,
Fair arguement and my thought process has been on similar lines. I m now trying to play devils advocate with it and seeing if there is a better alternative.
There is a lot of talk of bear markets but nobody is talking about businesses going into a bear phase. The worst case scenario is still a 8% GDP growth which is pretty amazing. The correction is just taking out the excessive froth in terms of valutaions and not in terms of froth in business growth ( maybe sectors like real estate might have business growth froth). So in a economy that is growing at 8% a year where do u position yourself in bets like Abbot or do u look at value in growth stocks.
Cheers
Ninad
Hi ninad
i think there is a lot excitement around real estate and a few other sectors. however that just a view - not somthing on which i would bet.
i am not too dogmatic on the type of stocks. i pick both types - graham type value and ones with growth too. however i try not to overpay for the growth stocks which is easy to do in all the euphoria.
my key criteria is how comfortable i am with the business and how well i understand it
Hi,
I think the growth of company's products is very less compared to average that of FMCG industry. Revenues increased from 562.3 Cr to 1346.7 Cr between 1997 and 2007, growth of just 9.12% CAGR over 10 years. The same is the case for profits. Inflation in India is at 7%. 2% difference will not make a good equity investment. 10% growth per year seems essential.
Hi chinmay
topline is growth a determinant of the final instrinsic value, but it is not the sole determinant of your stock returns.
The ROE of the company, the valuation, growth and discount rate or inflation all together determine the stock returns.
for ex: if a stock grows at 6% p.a, returns 30% as ROE, gives back all the excess cash as dividend will give you a return higher than inflation if the PE increases from say 10 to 15 in 2 years.
so growth is an important input, but not the most critical although everyone in the market gives it the highest priority
regards
rohit
I am not giving a priority but even Benjamin Graham emphasized that over ten years, the company should have grown by 33%. In US, average inflation is at 2-2.5%. That's why he didn't require a lot of growth to beat inflation but the story in India is different. We at least need to double earnings in 10 years just to beat inflation of 7%.
Hi,
The company has no debt and an approximate cash of 300 Crs.
Not sure how you got the Rs 300 cr figure - is this the 297 cr investments (I think it is)?
Thanks
Ravi
Hi ravi
yes ..it is the 297 crs investment figure on the balance sheet
regards
rohit
Valuation
The company current sells at around a PE of 13.5 (after taking out the cash). A rough calculation (ROE = 20%, growth around 7-10% and CAP of 8-10 years) would give an intrinsic value of around 3000 Crs. This valuation does not include upside from Global brands or any acquisition. Those would be icing on the cake, but I would not value them as yet.-----
just wanted to ask, what rough calculation u did to arrive at Intrinsic value?
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