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Castrol: Time to overhaul! - Views on News from Equitymaster
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Castrol: Time to overhaul!
Jan 16, 2006

Performance Summary
The ground below is slipping at a fast clip as far as Castrol is concerned, if the full year performance of the company is any indication (December ending). While the topline grew at a commendable pace, higher raw material prices and competitive pressure depressed margins for CY05. If not for the decline in depreciation charges, net profit would have fallen at a much faster pace.

(Rs m) 4QCY04 4QCY05 Change CY04 CY05 Change
Net sales 3,543 3,812 7.6% 13,102 14,304 9.2%
Expenditure 3,027 3,441 13.7% 11,026 12,187 10.5%
Operating profit (EBDITA) 516 370 -28.2% 2,076 2,117 2.0%
EBDITA margin (%) 14.6% 9.7%   15.8% 14.8%  
Other income 74 82 11.0% 227 201 -11.7%
Interest 11 5 -56.6% 29 30 4.9%
Depreciation 143 43 -70.3% 249 189 -23.9%
Profit before tax 436 405 -7.0% 2,026 2,098 3.6%
Extraordinary expenditure (73) 8   (73) 8  
Tax 138 96 -31.0% 678 638 -5.9%
Profit after tax/(loss) 224 318 41.5% 1,275 1,468 15.2%
Net profit margin (%) 6.3% 8.3%   9.7% 10.3%  
No. of shares (m) 123.6 123.6   123.6 123.6  
Diluted earnings per share (Rs)       10.3 11.9  
Price to earnings ratio (x)         22.3  

What is the company's business?
Castrol India is the country’s largest MNC sector lubes manufacturer and marketing company with a market share of nearly 20%. The company has a strong marketing network in the 'bazaar' segment and has a stronghold in the OEM (original equipment manufacturing) and tractors segment. Rising competition from PSU majors (that have competitive advantage owing to retail outlets) is one of the major threats Castrol is faced with. However, the company has entered into an agreement with Essar Oil and Reliance to market its lubricants through their retail outlets. Although, not of much help currently, this pact is likely to help Castrol from a long-term standpoint. The company is also making concerted effort towards lowering its dependence on lube sales.

What has driven performance in CY05?
Non-automotive powers growth: Castrol's performance has to be viewed in the backdrop of rising competition from PSU oil majors like BPCL, HPCL and IOC (both in the retail and OEM segments). Castrol continues to have a strong foothold in the 'bazaar' segment (the automotive spare parts retailers) and this has been the key growth driver, given the technology know-how and brand equity. The need to de-risk the business model away from the automotive segment in light of higher competition has resulted in the management also focusing on non-automotive segment (consists of supplies to manufacturing related projects, especially in the area of transport equipment manufacturers and auto component manufacturers). Given the increased activity in the non-automotive segment, this division has outperformed at the topline level and we expect this trend to continue. Compared to our CY05 topline estimates, while the automotive segment was lower by 50 basis points, non-automotive sales estimates were in line.

Non-automotive segment sparks…
(% sales) 4QCY04 4QCY05 Change CY04 CY05 Change
Automotive 2,996 3,232 7.8% 11,117 12,059 8.5%
PBIT margin 15.2% 9.5%   17.4% 15.3%  
Non-automotive 547 580 6.1% 1,985 2,245 13.1%
PBIT margin 12.5% 11.6%   10.3% 15.0%  
Overall PBIT margin 14.8% 9.8%   16.4% 15.2%  

Margins - A mixed bag: With crude prices rising sharply in the global market, base oil prices (the key raw material that is processed to make lubricants) also rose sharply, which is reflected in the operating margins (down 100 basis points YoY). While the full year PBIT margins of the non-automotive segment expanded, in 4QCY05 there was a contraction. Castrol, in the retail segment, also faces heat from weakening pricing power in light of higher competition. Compared to our CY05 estimates, the non-automotive margins expanded 100 basis points more.

Depreciation saves the day: Despite a 28% YoY decline in operating profits in 4QCY05, PBT declined only by 7% owing to lower depreciation charges. Castrol incurred Rs 140 m towards re-launch of the 'Castrol' brand in 4QCY05, which if we exclude, translates into a 1% decline in operating profit YoY. However, brand re-launches and increased adspend are a necessity and therefore, we view it as normal business activity. Excluding extraordinary items, net profit in CY05 has increased by 8%, which is marginally higher than our estimates.

What to expect?
The stock currently trades at Rs 265 implying a price to earnings multiple of 21 times our CY07 earnings estimate. Considering the weakening fundamentals, we believe that the valuations are at a significant premium and therefore, suggest investors to exercise caution. The company has announced a final dividend of Rs 4.25 per share, thus taking the total dividend for the year to Rs 8.25 per share (3.1% dividend yield). However, there are 'open offer' expectations from the parent major (BP), which has prompted a sharp upmove in the stock recently (the earlier open offer price was Rs 350 per share in 2001). If at all there is an open offer, we suggest investors to opt for the same (As on December 31, 2005, foreign promoters held 71.03% stake in the Indian subsidiary).

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