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Castrol: The same old story! - Views on News from Equitymaster
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Castrol: The same old story!
Apr 22, 2006

Performance Summary
Castrol India, the lubricants major, announced its first quarter results yesterday (December ending company). As has been the case in the past, given the company's strong brand image in the lubricants segment, topline growth continues to remain encouraging. However, with raw material prices showing no signs of receding, growth in net profit was muted.

(Rs m) 1QCY05 1QCY06 Change
Net sales 3,197 3,757 17.5%
Expenditure 2,731 3,257 19.3%
Operating profit (EBDITA) 466 500 7.4%
EBDITA margin (%) 14.6% 13.3%  
Other income 55 42 -22.8%
Interest 8 7 -18.5%
Depreciation 49 42 -14.4%
Profit before tax 463 494 6.6%
Extraordinary expenditure - -  
Tax 143 172 20.2%
Profit after tax/(loss) 320 321 0.6%
Net profit margin (%) 10.0% 8.6%  
No. of shares (m) 123.6 123.6  
Diluted earnings per share (Rs) 2.6 11.9  
Price to earnings ratio (x)   19.9  

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 efforts towards lowering its dependence on lube sales.

What has driven performance in 1QCY06?
Value growth is the key: In the latest annual report (December ending 2005), the company has highlighted few macro drivers that influence lubricant demand and how they are changing (on the automotive side). Firstly, the point-of-purchase of motorcycle owners, the fastest growing segment in the Indian automotive sector, is steadily shifting from petrol pump to workshops (for changing lubricants). Castrol is the market leader in the bazaar segment (i.e. workshops, automotive spare sparts dealers). Secondly, with the advent of advanced new technology four-wheeler vehicles being sold in the country, the replacement cycle is being stretched (the frequency for lubricants replacement is getting higher). Thirdly, as more high-technology four wheelers are sold, as per industry research, owners are becoming more brand conscious. And lastly, the rapid infrastructure development and lower interest rates is expected to drive auto demand (expected to track GDP growth in the long-term).

In this backdrop, we expect realisations to grow at a faster pace than volumes for the company in the next three to five years. In 1QFY06, while the automotive revenues grew at a robust 19% YoY, non-automotive revenues grew at a slower rate of 10% YoY. In the non-automotive segment, growth is largely driven by the level of industrial activity in the country. With the index of industrial production (IIP) growing at over 8% YoY, the performance of this division will be in tune with the same (value growth may be higher owing to the product mix). While we acknowledge the fact that Castrol has a strong brand in its favour, the fact that PSU marketing companies (with petrol pump distribution) getting aggressive, the overall market share of Castrol will come under pressure.

Non-automotive segment sparks…
(% sales) 1QCY05 1QCY06 Change
Automotive 2,673 3,179 18.9%
PBIT margin 13.1% 12.9%  
Non-automotive 523 579 10.5%
PBIT margin 14.5% 13.7%  
Overall PBIT margin 13.4% 13.0%  

It is the same old story: The cost of base oil (key raw material) has been on the rise (increased by 22% YoY in CY05). However, favourable forex on imported raw material, reduction in customs duty rates and continued focus on supply chain efficiencies enabled the company to restrict the annual increase of the unit cost of material to 8% YoY in CY05. While the company has been raising prices (including 1QCY06), given the weaker bargaining power on supplies to manufacturers, overall margins have declined owing to the company's inability at passing the entire increased costs onto the buyers. We have a very cautious view on the margins front going forward.

Over the last few quarters: While there is nothing significant to mention about the decline in other income and interest charges, it is important to highlight the fact that the growth in topline in 1QCY06 is relatively higher than the average in the last few quarters. Though operating margins are higher on a quarter-on-quarter basis, on a YoY basis, they are lower.

What to expect?
At Rs 237, the stock is trading at a price to earnings multiple of 19.9 times trailing twelve months earnings. We continue to have a 'Sell' view on the stock. While the stock was in the limelight based on rumours about a potential open offer from the parent company (British Petroleum), we suggest investors not to read too much into it. Until there is an official announcement, such rumours should not be construed as a reason to invest into the stock.

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