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Castrol: Not out of the woods

Jul 10, 2002

Over the past week, Castrol India Ltd. (CIL) has been heating up on the bourses. The scrip has increased by an estimated 5% to touch Rs 200 levels. With decanalisation of base oils and decontrol in sale of auto lubricants during the nineties, private sector companies experienced respectable growth. However, over the past two years the industry has experienced challenging times. The recent interest in CIL is due to the dual effect of a new agreement signed with Telco and revival in the auto sector, especially commercial vehicles (CV). Diesel engine oil for CVs constitute the largest share of lubes consumption. As per the agreement, Telco will endorse gear-box oils, greases and coolants of CIL for use in its CVs for a period of 5 years. In 2000, the two companies entered into a similar agreement for engine oil in Telco vehicles driven by Cummins engines. In 4-stroke, two-wheeler engine oils (Active 4T), the company has an agreement with LML. The agreements are likely to improve distribution reach of CIL products. Also, stickiness of products could increase. With the auto sector, across the board, registering improved volumes, factory fill sales is likely to experience improved growth.

Through the nineties, though volumes were stagnant, industry size grew from an estimated Rs 35 bn to 55 bn. But, since 2000, industry and private sector companies have come under pressure, as volumes contracted, competition eroded prices and consumer behaviour trends seem to have saturated. Lubricants business over the past two years has contracted with industry volumes declining by an estimated 10% to 900,000 tonnes.

Volumes are likely to have been impacted, as auto and capital goods industry experienced a downturn. Also, refill times are likely to have increased, as automobile engine quality improved and lube manufacturers introduced higher resistant products. Therefore, replacement sales is likely to have been adversely affected. As per some estimates, refill time has almost doubled, which suggests that new vehicle lube demand would have to double to maintain existing volumes. We reckon, the above-mentioned trends in the auto and lubes industry are likely to continue, which could keep pressure on volumes. Also, improving road infrastucture could reduce use of lubricants, as fuel efficiency improves and break-downs decline.

Castrol has been the pioneer in altering lube purchase pattern. Since decontrol in the industry, share of 'bazaar' segment in lube sales has reportedly increased to 73%, as petrol pumps lost their domination in lube retailing. Going forward, incremental penetration of 'bazaar' sales is likely to prove challenging. That said, 'bazaar' sale includes garages and service stations, which are key drivers of the segment. Consequently, lube manufacturers are focusing on this segment to influence the purchase decision. This suggests that the decision maker is not the end consumer. Also, purchases are not implusive but dependent on vehicle-maintainence patterns. Therefore, one could question the traditional market view of the scrip being classified as consumer product.

At Rs 199, CIL is trading on a multiple of 18.7x 1QFY03 annualised earnings. Deregulation in petroleum marketing could offer new growth opportunities, as lube manufacturers could gain access to the fuel retail outlet channel. But this could materialise over the medium term.

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