GlaxoSmithKline Consumer

With a limited product portfolio and unexciting historic growth, GlaxoSmithkline Consumer Healthcare (GSK Consumer) has traded at a significant valuation discount to FMCG peers, in the stock market. However, the company’s stock now merits a re-rating, after renewed efforts by the company to enter new categories, an accelerated pace of new launches and strong profit growth in recent quarters.

Investors can consider accumulating the stock even after its 33 per cent gain from the March lows, as the stock’s discount to peers offers upside potential.

At its current price of Rs 828, the GSK Consumer stock trades at a PE of 16 times trailing 12-month earnings while multiples hover at 22-24 times for Nestle India, Colgate Palmolive, Godrej Consumer and Dabur. The stock is at about 14 times its estimated earnings for 2009, again at a sizeable discount to most rivals.
Strong volumes

After managing a 14 per cent compounded annual growth in sales in the three years to 2007, GSK Consumer’s sales growth shot up to 21 per cent for 2008. Strong volume growth in the Horlicks franchise driven by higher offtake and brand extensions, higher realisations due to price increases and a surge in export revenues aided this improvement.

A sharp increase in input costs prevented the expansion in topline from being mirrored in net profits, which rose by a muted 15 per cent. 2008 saw a sharp upward spiral in prices of inputs such as wheat, malt extracts and milk.

Numbers for the March 2009 quarter show that the company has sustained its growth momentum this year. Net sales were higher by an impressive 31.4 per cent in the first quarter.

Though excise duty savings brought in about 3 per cent of this expansion, this was also backed by an impressive volume growth of 20 per cent (21 per cent in Horlicks, 8 per cent for Boost and 27 per cent for biscuits).

A 13 per cent growth in domestic offtake of malted drinks led mainly by Horlicks, a 3.5-4 per cent pipeline filling for new products and a surge in exports helped drive this growth.

Given that malted drinks remain an under-penetrated category, promotional efforts, better distribution reach and a value-oriented strategy hold further potential to increase domestic sales.
Leg up from exports

GSK Consumer’s exports to neighbouring markets such as Sri Lanka, Nepal, Bangladesh and West Asia have also been a key driver, seeing a 45 per cent expansion in the first quarter.

A shifting of the manufacturing base for some products to India (by the parent) and market share gains for brands for Horlicks and Boost in these markets have both helped this growth. The latter ties in with the headway made by many Indian FMCG brands in the neighbouring markets.

Exports, which have been a key contributor to GSK Consumer’s growth in recent quarters, also hold further potential for scaling up.

The March 2009 quarter saw GSK Consumer’s net profits expand by a higher than expected 48 per cent, on the back of higher operating profit margins.

Higher realisations resulting from price increases (of 5.5 per cent) taken in January 2009 and benefits from excise duty cuts (about 60 per cent of the company’s manufacture is subject to excise duty) triggered margin expansion.

Though input cost pressures did not abate materially (material/packaging costs up by 28 per cent over last year), they were more or less offset by the price increases and a cutback in advertising and promotional spends for the quarter, as the company temporarily “tightened its belt” on ad spend.

While inflationary pressures are likely to subside a little in 2009 (malt extract and packaging prices have corrected, while milk and sugar remain upward bound), the company is unlikely to see substantial savings in input costs, as will some other FMCG makers.

However, that is not a big concern, given GSK Consumer’s dominant share of malted drinks market (70 per cent, straddling brands such as Boost, Viva and Maltova and Horlicks) which endows it with strong pricing power.

While the company has delivered exceptional profit growth in the latest March quarter, growth of this order is unlikely to be sustained in the coming months and may moderate to the 20 per cent range.

As GSK Consumer steps up its pace of product launches and supports them with brand building efforts, ad spends may climb back to 13-14 per cent of sales, from the current 11.5 per cent.
Broadening the basket

GSK Consumer has already embarked on a two-pronged strategy to expand its somewhat narrow product portfolio.

First, it plans to leverage the Horlicks brand to launch a wider range of nutrition products and functional foods. Second, it plans to draw more actively on its parents’ portfolio for the Indian markets.

Junior Horlicks and Mother’s Horlicks have already captured key niches in the beverage market and Horlicks Lite (suited to Diabetics) Women’s Horlicks (specially formulated for women) have added to this set of extensions in 2008.

The first quarter of 2009 has seen GSK Consumer’s foray into functional foods through the launch of Horlicks Nutribar, a healthy snacking option for young adults. ActiGrow, a high-protein baby food, was also rolled out this quarter. These supplement Horlicks and Lite Bite biscuits which are targeted at children.

The brand Horlicks has also been extended into the ready to drink (RTD) segment, through tetra packs. While a foray into RTD has already been attempted in the past, the foray into functional foods holds considerable promise for broadening the company’s portfolio.

While the new category forays will peg up advertising and brand building spends over the next two years, they have the potential to reduce the company’s significant reliance on one brand (Horlicks) and one category (malted drinks) for growth and profitability. That may remove a key impediment to better valuations for the stock.