They have a poor capital allocation track record something which has come to haunt them over the last few years.
Their India business is a cash generating machines. GCPL enjoys strong market positions in the bulk of their India business – #1 in Household Insecticides, #1 in hair dyes and #2 in soaps. The entire operation makes 75%+ ROCEs and grow in mid to high single digits. The business needs negligible capex and works on a negative working capital cycle – pay your supplies later and sell on cash to your distributors. On its own, this business is amongst the most profitable FMCG business in India easily comparable to HUL or Nestle. Given that the business grows barely around 10% and generates 75% ROCE, you can imagine there is massive excess cash being generated every year. The promoters could have chosen three ways to make use of this excess cash 1) return it to shareholders via high dividend payouts. But they haven’t – HUL and Nestle have 80-90% payout while GCPL has averaged <30% for most of the last decade 2) aggressively invest in their core operations – may be cut prices in insecticides to drive rural penetration or may be invest aggressively to build hair colour distribution in the salon channel where Loreal absolutely dominates them. Or may they make a ‘serious’ marketing effort to extend their Cinthol brand into adjacent personal care categories. My point is that could GCPL not live with a 35% ROCE instead of 75% but drive 15% revenue growth instead of a mid-single digit growth? The ‘optical ROCE’ drop by investing in core areas is not necessarily dilutive to intrinsic value as growth is higher and can sustain for longer. 3) GCPL has instead chosen the third route – using the excess cash to acquiring business in Africa, United Kingdom, Latin America and Indonesia. And that has not turned out well – the capital deployed there has earned sub-par return versus what shareholders would have hoped to earn was the capital returned to them.
People will point that its easy for me to say this with the benefit of hindsight. I won’t argue to that point except that base rates also suggest that inorganic international endeavours by Indian companies don’t work – no matter how convincing a story the management and the PR machinery portrays at the time of the M&A. Its surprising that even now GCPL management is open to more international M&A as stated on their recent results call.
Between FY10-20, GCPL invested bulk of its excess cash from India into international markets. As of FY20, international markets comprise 80% of the capital deployed and have earned an average of 7% ROCE over FY10-20. That is about a shareholder would make by investing in Indian FDs without the need to venture in exotic regions like Africa. A smart investor would have used the excess cash from ‘optimally paid’ GCPL dividends to invest in far better opportunities.
70% of GCPL’s business in Africa is selling hair ‘wigs’ to African women. Do spare some thought as to why an Indian FMCG company is selling hair wigs to African women in a commodity market rampant with imports from China. The hair wig busines is not even your typical FMCG business – it is more like fast fashion, low gross margins with fast changing styles.
Some people would again point that GCPL has screwed up in Africa but done better in Indonesia. I am afraid that’s only partly true. The Indonesia business on its own earns a ROCE of 45% but then GCPL did not get it for free. They paid the former sellers, right. It’s like if I invest in HUL at market prices, I don’t make a 100% ROCE like HUL reports, my ROCE is actually sub 5%. Coming back to GCPL Indonesia, the reported ROCEs for this business (including goodwill) are about 20%. This after nearly a decade of investing in Indonesia. Compare this to the 75%+ ROCE made by the Indian operation.
Obviously, following a large international playbook is risky and not sustainable and if GCPL got away with Indonesia, the larger subsequent bet in African hurt them badly.
This begs the question – why would have GCPL done this? The promoters have their own grand answers which you will find if you read the last 10-year annual reports. But here are some reasons I could think of 1) thinking they ‘own’ all the cash generated and would rather invest it somewhere than return it back to minority shareholders 2) investing in M&A helps build topline, increases international presence – this well serves promoter interests of being seen as owning a large multi-national business – the business press rewards revenue and market cap size and not efficient use of capital (RIL is the best example) 3) sometimes – it’s just plain overconfidence. Knowing well that others have struggled to do it does not deter them – it’s what Daniel Kahneman calls taking only an ‘insider’s view’: doing a biased internal assessment but failing to take other people’s opinion especially from those who have attempted something similar. Everyone succumbs to these biases – companies and individuals except that there is a minority among both who are better able resist these temptations or wager in smaller bets at a time.
Don’t forget that at the consolidated level, despite all the international adventures, GCPL makes a ROCE of 18-20% which puts in a good place and better than a vast majority of Indian businesses. The point here is that a potentially 75%+ ROCE business with consistent high payouts (which could have been re-invested by investors elsewhere) was reduced to a 20% ROCE business due to poor capital allocation. Adi Godrej in 2010 had guided for GCPL to grow its revenues by 10x in 10 years. Not only have they just about reached half of that mark but with sharply deteriorating incremental ROCE.