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Tuesday, August 22, 2006

The Plunge - 3

Godrej Soaps
Godrej Soaps Ltd was a spin-off value play. It owned various popular brands, in addition to a contract manufacturing (CM) operation using their plant’s surplus capacity. Typically, the FMCG (Fast Moving Consumer Good) soap and cosmetic line of business is a lucrative one if the brand building has already been done. It was so in Godrej’s case (Godrej da jawaab nahin was a slogan I remembered from my early school days). Their marketing machinery was pretty good, worthy of giving a run for the money for the MNC brands. Cosmetic marketing is basically a combination of peer pressure and a scare tactic. It usually plays on the fear of being left out, whether it be Listerine initially in US on halitosis or Fair & Lovely cream with its play on not being fair being a marriage breaker.
However, the problem with Godrej was that it was hard to delineate the profitability of the FMCG business with the CM operation. CM operations tend to usually suck cash due to huge inventory needed. This is not true for FMCG business, where the cost of the inventory tends to be lower in relation to sales (the good ones have negative working capital). It is for a similar reason that conglomerates command a lower P/E than focused companies. The good thing with GSL was that the management was aware of this and decided on the spin-off. This made GSL a typical event play.
The spin-off of GSL into Godrej Industries Ltd (GIL) and Godrej Consumer Products Ltd (GCPL) happened and the release in value was almost immediate. I bought the whole entity at Rs.55. When GCPL listed, it started quoting at Rs.58 in Oct, 2001. The price at which GIL was quoting was all profit for me. However, attracted to the value of the intangibles, I was buying demerged GCPL in 2001. I ended up selling GIL for Rs.16 in Apr 02 and most of GCPL around 150 in Oct 03 attempting to release my capital.
I have tried to evaluate these two batches of GCPL differently. One being the spin-off play for my GSL purchases and the other a regular value play for GCPL stand-alone purchases. It turns out that the Spin-off play (GCPL, GIL collectively) returned me an IRR of 75% (monthly 4.8%) in a time period of less than 3 years. Excess return measured by NPV was at Rs.2,277 against my initial cost of 1,379 and future date NPV till 2004 was 3,199 at 12%. I sold the rest of GCPL(stand alone) in Feb 04 at around 182. It returned me 81.79% in 3 years with 5.11% monthly and NPV of 4,410.

However, I was in for another surprise with GCPL. I did not seem to have valued GCPL correctly when I sold it. In the 11 months, it went all the way up to 276. I have again and again sold early as my later evaluations will illustrate. It is very difficult for me to predict where value discovery process by the market stops and speculative activity begins. Hence, I take the best course of action that protects capital. I re-deploy it into other investments with better chances of success. In GCPL’s case I decided to buy again in Jan 05 at 277 and the returns till date have been stellar. An IRR of 123% in 15 months at a monthly rate of close to 7%. An NPV of 7,306!!!! However, this story has not ended yet.

The funny thing is I don’t seem to have evaluated the financials of GCPL. I need to do that to make sure I do not need to act soon at least to release my capital at current prices. The FMCG play in India seems pretty straight forward so far. The IT industry brought higher disposable income in the hands of the educated middle class. This is one of the aspects of growth in the services industry in a heavily populated country. A manufacturing led growth does not necessarily lead to growth in PDI. The value add (Price less material cost) for services is very high, especially so for IT industry. ( I am reminded of the infinite wisdom of the KGST who decided to tax the software CDs at their sale price. Either they had no concept of IP and intangibles or they didn’t care to make the difference).

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