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Castrol: Going out of hands - Views on News from Equitymaster
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Castrol: Going out of hands
Jul 24, 2006

Performance summary
Castrol announced its results for the second quarter ended June 2006 (December ending fiscal). Topline registered a growth of 21% YoY for 2QCY06. Operating profits fell by 23% YoY due to margin contraction (680 basis points). Higher base oil prices were the key factor behind this dismal performance. However, a 587% YoY increase in other income (due to gain on disposal of property) prevented the bottomline from falling significantly.

Financial performance…
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Net sales 3,955 4,768 20.6% 7,152 8,526 19.2%
Expenditure 3,209 4,193 30.7% 5,940 7,450 25.4%
Operating profit(EBDITA) 746 575 -22.9% 1,211.7 1,075.4 -11.2%
EBDITA margins(%) 18.9% 12.1%   16.9% 12.6%  
Other income 29 47 60.1% 84 89 6.2%
Interest expenses 8 7 -9.2% 16 14 -14.0%
Depreciation 50 45 -8.7% 99 88 -11.5%
Profit before tax 718 570 -20.6% 1,181 1,063 -10.0%
Extraordinary income - 154 - - 154 -
Tax 223 221 -0.9% 366 393.2 7.3%
Profit after Tax 495 503 1.7% 814.5 825 1.2%
Net profit margin(%) 12.5% 10.6%   11.4% 9.7%  
No.of shares(m) 123.6 123.6   123.6 123.6  
Diluted earnings per share* 4.0 4.1   6.6 6.7  
Price to earning ratio.(x)         15.3  
(*trailing twelve month earnings, excluding extraordinary income)

What is the company’s business?
Castrol India is the largest private sector MNC engaged in the production and marketing of lubricants. Segmental operation consists of automotive and industrial lubricants. Castrol has a share of 20% in the segment. It markets its automotive lubricants under two brands- Castrol and BP. Company has 5 manufacturing plants across the country, along with a wide distribution network of 270 distributors, servicing over 70,000 retail outlets. Castrol 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, initiative is not yielding benefits as have now due to lower market share of Essar and Reliance.

What has driven the performance in 2QCY06?
Sales analysis: Castrol’s automotive segment (retail sales and supply to original manufacture such as Telco) grew 22% YoY in terms of revenues, while the growth in non-automotive segment (industrial segment) was 16%. In 2QCY06, automotive segment contributed 86% of the total revenues of the firm and continued to be the major revenue driver. In the last two years, it was the industrial segment that was driving the topline while providing stability at the operating profit level. But this fiscal year, the automotive division has grown at a faster clip, which in our view, is largely a factor of price increases. The average realisation of lubricant sales in CY05 was higher by 8.5%, as the company passed on the rise in input cost (though not commensurate with the rise in raw material prices). Much of the topline growth in 1HCY06 was on account of higher price realisations.

Segmental Analysis…
Particulars 2QCY05 2QCY06 % change 1HCY05 1HCY06 % change
Automotive Revenues 3,393 4,116 21.3% 6,066 7,295 20.3%
PBIT margin 18.2% 15.2%   15.9% 14.2%  
Non-automotive 562 653 16.1% 1,085 1,231 13.4%
PBIT margin 15.1% 13.3%   14.8% 13.4%  
Overall PBIT margin 17.7% 14.9%   15.8% 14.1%  

Margin blues: Castrol saw a contraction in its operating margins for the 2QCY06 by as much as 680 basis points. Margins were under pressure due to higher input prices. As a matter of fact, consumption of raw material increased by 40% during the quarter. Automotive segment registered PBIT margins of 15.2% as against 18.2% during the previous quarter, revealing the inability of the company to pass through the rise in expenses fully. Non- automotive also registered a lower PBIT margin of 13.3% (down 180 basis points from the previous quarter).

Expenditure break up…
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Consumption of raw material 2,284.5 3,193.1 39.8% 4,207.10 5,647.20 34.2%
as a % of sales 57.8% 67.0%   58.8% 66.2%  
Staff Cost 177.7 199.5 12.3% 325.10 343.60 5.7%
as a % of sales 4.5% 4.2%   4.5% 4.0%  
Advertisement Cost 142.9 176.1 23.2% 295.6 296.6 0.3%
as a % of sales 3.6% 3.7%   4.1% 3.5%  
Freight cost 161.7 180.4 11.6% 303.1 331.2 9.3%
as a % of sales 4.1% 3.8%   4.2% 3.9%  
Other expenditure 442.3 444.2 0.4% 808.90 831.60 2.8%
as a % of sales 11.2% 9.3%   11.3% 9.8%  

Other income effect: Other income for the quarter increased by 60% YoY. The extraordinary income in 2QCY06 indicates the one-time profit on the sale of surplus land (to the tune of Rs 154 m). Marginal reduction in interest expenditure along with one-time income transformed the weak operating performance into a flat bottomline show. Net profit margins during the quarter were 10.6% as against 12.5% registered in the previous quarter (fall of 190 basis points). Excluding the one time other income, net profit margins stands at 7.3% (down 520 basis points).

Performance over the recent past…
(Rs m) 2QCY05 3QCY05 4QCY05 1QCY06 2QCY06
Sales growth(YoY) 9.6% 10.1% 8.1% 17.5% 20.6%
Operating profit margins 18.9% 16.0% 9.7% 13.3% 12.1%
Net profit margins 12.5% 10.1% 8.3% 8.6% 10.6%
Net profit growth(YoY) 5.0% 8.2% 41.5% 0.6% 1.7%

What to expect?
At the current market price of Rs 164, the stock is trading at a price to earnings multiple of 15.3 times trailing twelve month earnings, excluding extraordinary income. The company has declared a dividend of Rs 4 per share (dividend yield 2.4%). We continue to have ‘Sell” view on the stock. Operating performance of the company is going to be under pressure, as the company is not able to pass through the higher input cost to the consumers. Also, increasing competition from the oil marketing companies (OMC’s) will have a negative impact on Castrol’s market share and profit margins going forward.

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