Godrej Soaps demerger: Pros and cons

Godrej Soaps Limited recently decided to demerge into two separate entities. The company's consumer products (soaps and toiletries) business will be part of a new company called Godrej Consumer Products Limited (GDCP). The chemicals, medical, diagnostic, estate and strategic investment businesses will form part of Godrej Industries (the new name for Godrej Soaps). The demerger will take place in the ratio of 60:40, in favour of Godrej Industries. Godrej Soaps paid-up capital stands at Rs 600 m. After the demerger Godrej Industries (GDI) will have a paid up capital of Rs 360 m and the consumer products company will have Rs 240 m as paid up capital.

The demerger will be favourable for both companies, giving them the necessary edge to focus on their core businesses. It will be especially beneficial for Godrej Consumer Products Limited. In FY00, Godrej Soaps clocked an operating turnover of Rs 7.9 bn (including financial operations). Out of this, consumer products contributed Rs 3.8 bn (or 48%). The gross profit margin of this division works out to be Rs 16.7%, which is healthy.

The Godrej Soaps stock currently trades at Rs 56, at a P/e ratio of 5.5 times its FY00 earnings. If we were to value the demerged companies separately, the valuations will stand as under:

We estimated that after demerger the consumer products entity will get a P/e rating of 7.5 times its FY00 earnings, hence based on that the price per share of GDCP works out to be Rs 103 per share. Similarly, we estimate its chemical and other businesses to get a conservative P/e rating of 3.5 times. Based on this, the price per share of this company works out to be Rs 27.

Hence, if you were to buy 100 shares of Godrej Soaps today, at a price of Rs 55, your total cost will be Rs 5,500. Post demerger, you will have 40 shares of GDCP, meaning 40*103=Rs 4,134, and 60 shares of GDI, meaning 60*27=Rs 1,642. Therefore, the total value of your investments will stand at about the same as your cost, i.e. Rs 5,776.

In effect, we can say that there is not much to be gained or lost from entering the Godrej Soaps counter at this price. Please bear in mind that the P/e ratings that the two companies will get post split are just our assumptions. But post demerger, it will be interesting to see what valuation the Godrej Consumer Products Limited gets. It is only at that time, a correct estimate can be made on the fortunes of the two companies.