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Castrol: Makes a comeback?

Jul 23, 2002

In our flash report, we stated the performance of Castrol (India) Ltd. (CIL), prima facie, looked impressive. We held back analysis, as the numbers were much above expectations. That said, the topline continues to face challenges but benefits have accrued at the operating profit level with key cost heads registering declines. We had estimated gains from lower base oil prices.

(Rs m) 2QFY02 2QFY03 Change 1HFY02 1HFY03 Change
Net sales 2,993 2,984 -0.3% 5,640 5,507 -2.4%
Other Income 21 22 4.7% 59 65 10.7%
Expenditure 2,481 2,306 -7.0% 4,756 4,353 -8.5%
Operating Profit (EBDIT) 512 677 32.3% 885 1,153 30.3%
Operating Profit Margin (%) 17.1% 22.7%   15.7% 20.9%  
Interest 20 25 26.1% 38 47 23.6%
Depreciation 33 33 -0.9% 64 66 3.4%
Profit before Tax 480 642 33.6% 841 1,105 31.3%
Extraordinary items (12) (7)   (45) (7)  
Tax 133 199 50.2% 226 361 59.9%
Profit after Tax/(Loss) 336 436 29.8% 571 737 29.1%
Net profit margin (%) 11.2% 14.6%   10.1% 13.4%  
No. of Shares 123.6 123.6   123.6 123.6  
Diluted Earnings per share* 10.9 14.1   9.2 11.9  
P/E Ratio         16  
* annualised            

Over the past two years, CIL has been experiencing a challenging operating environment with volumes stagnating, increasing competition and volatile feedstock prices. With acquisition of parent company, Burmah Castrol, BP Amoco consolidated its presence in the country. Tata BP Lubricants (India) Ltd. was amalgamated with CIL with effect from January 1, 2001. Consequently, the numbers for both years is inclusive of Tata BP performance. Having still to establish the brand, the operations till last year were cash negative. Assuming no change in Tata BP performance, the picture for CIL is not very different for the quarter. Industry volumes are facing pressure as engine, lube and road infrastructure quality improves. And with absence of growth opportunities in developed markets, international players seem entering India on expectations of latent demand.

The performance is very similar to the previous quarter. Operating profits have received a boost from a spurt in operating margins, which have been lifted by a decline in operating costs. Expenses are largely lower due to softer base oil prices -- key feedstock -- YoY for both periods. CIL is known to enter into forward contracts for procuring feedstock, which offers greater visibility on costs. The company is likely to have benefited from softer oil markets during first quarter of 2002. Oil prices (Brent blend), during this period, were lower by 17.7% YoY, which is likely to have reflected on base oil prices. Therefore, gains have accrued more out of softening in the commodity cycle. In the recent past, despite strong brands, the company has not been able to pass through all the costs. That said, with crude oil prices rising in April & May '02, gains from lower base oil prices could reduce in the current quarter. The lower base oil prices have also given the company elbow room to get agressive on advertising for facilitating topline growth. In FY02, advertising costs, YoY, were flat with profits under pressure.

Interest costs, which declined for FY02, are on the rise. With business volumes not likely to have improved, lower feedstock costs and ERP systems to streamline processes, the higher interest is concerning. Extraordinary items pertain to amortisation of voluntary retirements (VRS) costs incurred in FY01 and FY02. Effective tax of the company has increased due to reduced fiscal benefits from the Silvassa plant.

The company could benefit from the upturn in the auto sector, especially commercial vehicles, which account for an estimated 70% of lube sales. The company has entered into strategic alliances with vehicle manufacturers for getting its products endorsed. With poor consumer awareness of lubricants among passenger vehicles, this could be an effective strategy to ensure consumer loyalty. Also, over the medium-term, with deregulation in petroleum marketing, lube manufacturers could gain access to fuel retail outlets.

At Rs 193 the scrip is trading on 16x 1HFY03 annualised earnings. Valuations on the counter have been slipping, as markets could be concerned over ability of Castrol brands to sustain margins. In FY02, the scrip was trading on 20.5x earnings. The market accords valuations to CIL similar to consumer product companies. Global lubricant majors tend to be classified as automotive consumer product companies, as they offer a range of car care and accessory products. Presence in these segments, which more closely resemble FMCG buying behaviour, could help ease stress on valuations.

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