Castrol: Margins magnify the bottomline

Apr 29, 2008

Performance summary

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• Topline increases by 11.5% YoY during 1QCY08.

• EBITDA margins expand to 23%, from 14.5% in 1QCY07.

• Other income zooms by 63% YoY during the quarter.

• Bottomline registers a growth of 75.3% YoY owing to operating margin expansion and higher other income, despite lower interest expenses.

Standalone financial snapshot

(Rs m)	1QCY07	1QCY08	Change
Net sales	4,421	4,929	11.5%
Expenditure	3,780	3,795	0.4%
Operating profit (EBDITA)	641	1,134	77.0%
EBDITA margin (%)	14.5%	23.0%
Other income	73	119	63.2%
Interest	9	13	52.9%
Depreciation	48	62	29.7%
Profit before tax	657	1,178	79.2%
Tax	242	450	85.8%
Profit after tax/(loss)	415	728	75.3%
Net profit margin (%)	9.4%	14.8%
No. of shares (m)	123.6	123.6
Diluted earnings per share (Rs)*		20.20
Price to earnings ratio (x)*		15.1

*On trailing twelve months earnings

What has driven the performance in 1QCY08?

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• Higher prices have led the 12% YoY growth in topline. The core lubricant business is driven more by value than volume, as the company’s focus has centered on advanced formulations required for modern automobiles and machines. While these machines use lower quantum of lubes, they require higher specification lubricants that are premium in nature. The improvement in operating margins to 23% for 1QCY08 has been due to a combination of pricing, improved sales mix and a reduction in the cost of materials (as percentage of sales).

• Raw materials costs declined by nearly 10% in 1QCY08, as percentage of sales. This reduction was achieved primarily through an effective procurement strategy. It more than offset the increase in both staff and advertising costs.

  Cost break up

  (Rs m)	1QCY07	1QCY08	Change
  Raw materials	2,786	2,630	-5.6%
  % sales	63.0%	53.4%
  Staff cost	191	219	14.6%
  % sales	4.3%	4.4%
  Advertising cost	167	199	19.4%
  % sales	3.8%	4.0%
  Carriage, Insurance & Freight	163	183	12.5%
  % sales	3.7%	3.7%
  Other expenditure	474	564	19.0%
  % sales	10.7%	11.4%
  Total cost	3,780	3,795	0.4%
  % sales	85.5%	77.0%

• Castrol continues to support its brands aggressively through innovative advertising and sales promotion initiatives as seen in the 19% YoY increase in advertising cost in 1QFY08.

• The company has started the rollout of some initiatives to improve and simplify the distribution management in the automotive part of the business. This is expected to improve productivity and release working capital on a sustainable basis.

What to expect?

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Castrol has improved operating margins again this quarter, signaling its ability to maintain bottomline buoyancy. The company is into strategic alliances with OEM partners like Tata commercial vehicles division, Tata passenger cars, Mahindra and Mahindra, Ford, JCB and L&T. It has also entered into a partnership agreement with Volvo cars. Castrol BikeZone – a franchised motorcycle servicing concept – is also set for fast expansion.

However, the environment is expected to be extremely challenging, with raw material cost expected to escalate sharply. Crude prices have moved up rapidly over the last two quarters and all the lubricant input prices have been reacting to this trend.

At the current price of Rs 304, the stock trades at a price to earnings multiple of 15 times its trailing twelve months earnings. Considering the dynamics and competitive landscape of the Indian lubricant industry, we believe that the valuations reflect the company’s growth prospects in the medium term. Hence we suggest investors to exercise caution at the current juncture.