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Shares in Godrej Industries rose +12% in August having hit their widest ever discount level of 69% at the end of July. Although the discount had already started to move in, mid-month the shares received a further boost from incorrect media reports linking Godrej Industries to a successful space mission (with the Godrej family involvement coming through a different unlisted holding company).

This rather odd turn of events serves as an apt prompt to provide an update on what has been a relatively unsuccessful investment for AGT – delivering an ROI of just +13% in Rupees and +0.5% in Sterling since 2019 (a meagre IRR of +3.5% / +0.1%).

As way of reminder Godrej Industries owns listed stakes in Godrej Consumer Products (49% of NAV), Godrej Properties (44%) and Godrej Agrovet (12%), as well an unlisted Chemicals business (8%) and a nascent finance business (3%).  Together the listed stakes account for >200% of Godrej Industries enterprise value.

Our initial thesis was predicated on the attractive quality of the underlying assets, most notably Godrej Consumer, and the prospects for long-term NAV growth. As well as this we thought the ~45% discount at which we started accumulating shares in 2019 to be appealing, with it having widened following the 2017 IPO of Godrej Agrovet and liked the alignment with a family with a track record of significant value creation and strong corporate governance. We have been both right and wrong.

On the NAV side of the equation performance has been satisfactory. From the date of our first purchase in February 2019 the NAV is up +68% – for a CAGR of +12%. Whilst this has slightly lagged the MSCI India (+74%) it compares favourably to the MSCI AC World (+58% in INR) and provides a good bedrock for returns.

It is however the discount which has been the problem – moving from 45% to as wide as 69% and to 64% currently. Such moves are

painful and frustrating. That said, we’d much rather lose money from discount widening than declines in NAV, viewing it as a temporary setback, rather than a permanent impairment of value.

Godrej Industries has a history of incubating and building businesses, before listing them, with Godrej Agrovet’s listing in 2017 having been the most recent. It is likely that Godrej Capital will follow a similar route, and we view this as a medium-term catalyst for improving interest in Godrej Industries shares and narrowing the discount. Arithmetically, prospective discount returns from such wide levels are significant, with a 50% discount resulting in a +37% return. As such, combined with the attractive nature of the underlying NAV, we remain optimistic and patient.

During the month Godrej Industries announced the launch of Godrej Capital as a new subsidiary to act as the financial services arm of the group. Having started with home loans under the banner of Godrej Housing Finance last year, the group will expand upon this to offer Loans Against Property (“LAP”).  Godrej have injected 1500 crore (3% of NAV) and believe the business will require a total of 5000 crore of capital in order to reach their target of a 30,000 crore ($4bn) balance sheet by 2026.

The Godrej family have a successful history of building businesses – such as Godrej Properties and Godrej Agrovet – and then listing them once they mature. We expect a similar path here and view the Godrej Group as rare in our universe in terms of having strong brand and trust equity than can be used to spawn new businesses. Over time the presence of an attractive unlisted asset in Godrej’s NAV could well give other investors a “reason” to invest in the holding company as opposed to their listed underlying holdings directly, thereby acting as a force to narrow the discount. At 62% we believe the current discount to be unjustifiably wide, with the prospects of strong discount returns from such a level.

Shares in Godrej Industries were up +10% in December, as the discount narrowed from 62% to 57% on a flat NAV. Since initiating a position in Feb-19 the discount has widened materially (from 45% to as wide as 67%), acting as a headwind to returns, and partially diluting the strong NAV growth (+20% CAGR) we have experienced. Of late there have been reports that the Godrej family are looking to separate and divide their assets as part of a generational transition. It is unclear what form this might take, or whether this will impact Godrej Industries, but the family have a history of creating value for all shareholders.

During the month Godrej Consumer Products (“GCPL”) – which accounts for 47% of Godrej Industries’ NAV – held a capital markets day. This was the first proper opportunity for Sudhir Sitapati – who started as CEO in October following a 22 year career at Hindustan Unilever – to lay out his vision for the business. The investor day involved a candid outsider’s assessment of GCPL’s performance, strengths and weaknesses. As well as this GCPL set out their mid-term targets and strategy, aiming for double-digit volume growth led by increased penetration and higher media investment, whilst targeting 150-200bps of margin expansion. With the new CEO and (relatively) new head of the Africa business, GCPL appears well positioned to drive growth in value for Godrej Industries in the years ahead.

Godrej was the second-largest contributor to returns in March, with strong share price performance driven primarily by a tighter discount. We first initiated a position in Godrej in Feb-19 – since then, the share price has increased approximately +13%. However, this performance over the past two or so years masks an important underlying reality: the NAV has grown +32%, meaning that we have been penalised by a widening discount to NAV (which now stands at 53%).

Although discount widening is frustrating, it can also be viewed as a deferred source of outperformance. In our view, Godrej Industries’ collection of companies is high quality, operating in markets with favourable demographics, and managed by a family with a history of excellent capital allocation and a long-term view. Not only does this tilt the odds of robust future NAV growth in our favour but, under such a scenario, a discount of 53% seems unlikely to persist indefinitely. We retain conviction in Godrej Industries and its potential for long-term outperformance.

Godrej Industries was the largest detractor from performance during the period, subtracting 35bps from returns as it suffered from a painful widening of the discount from 57% to 63%. The shares returned -11% as the NAV grew +3%. On the NAV front, we are optimistic, particularly at Godrej Consumer (51% of NAV), where an increased focus on health and hygiene should drive domestic demand, and new management additions should improve their performance in the more troubled Africa business. With time, we expect that the discount will narrow (we note that the average discount over the medium-term has been c. 40%), which will provide an additional tailwind to returns on top of NAV growth.

Godrej Industries was the second-largest contributor in June, as both a strong NAV (+15%) and a narrowing discount (60% to 54%) combined to drive the share price +31% higher. Godrej is an Indian holding company which owns controlling stakes in three listed businesses: 1) Godrej Consumer Products (“GCPL”), a leading Indian consumer products company with an increasing presence in other emerging markets; 2) Godrej Properties, an Indian property developer exposed to the trend of urbanisation; 3) Godrej Agrovet, a diversified agri-business benefiting from the formalization of Indian agriculture.

The jewel in the crown is GCPL (54% of NAV), which holds dominant market positions in hygiene (soaps, handwash, bodywash), hair care, and household insecticides. GCPL benefits from exceptional brand equity and is home to a number of India’s most trusted consumer brands, which has translated into strong top-line growth and attractive margins. This has been complemented by inorganic growth to expand the business outside of India, most notably in Indonesia and West Africa. Over the last decade sales have grown at 17% CAGR, however the last few have been much tougher going. In India sales growth has been inhibited by demonetisation, the introduction of Goods and Services Tax (GST), and a general slowing of the Indian economy, all of which have dampened growth in consumer demand. There have also been specific issues with unlicensed competition in the household insecticides business, although this now seems to be abating. Growth in Indonesia has been mixed, although over the last year very strong, whilst the African business, which is less developed, has been more sluggish. All of this has been compounded by COVID-19 and the subsequent lockdowns, which were particularly strict in India. However, we view these as short-term issues which distract from the highly attractive long-term growth trends in GCPL’s key markets. Management has a strong track record of product innovation and leveraging the brand to drive organic growth. Indeed, we are already seeing this in new hand-wash product launches to capitalise on the increased focus on hygiene in the COVID-19 environment. As such we remain excited about the prospect of future growth.

Since initiation of the position in early 2019, returns have been below expectations (although we remind readers that our investment timeframes last much longer than a year), with the primary culprit being an expansion in the discount from c. 45% to 54% currently. We continue to believe that Godrej Industries can deliver highly attractive returns from both underlying NAV growth and a narrowing of the discount from the exceptionally high levels seen currently.