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Castrol: A smooth performance - Views on News from Equitymaster
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Castrol: A smooth performance
Jul 24, 2007

Performance summary
  • Topline grew by 13.3% YoY while bottomline grew by 31% as compared to the same quarter last year.

  • A lower expenditure growth of 4.8% YoY resulted in an improved EBITDA margin of 18.6% as against 12.1% during last corresponding quarter. Half-yearly margin for the current calendar year stood at 16.8%.

  • Other income declined by 61% as the corresponding quarter last year included profit on sale of premises of Rs 154 million.

Financial snapshot…
(Rs m) 2QCY06 2QCY07 Change 1HCY06 1HCY07 Change
Net sales 4,768 5,401 13.3% 8,526 9,822 15.2%
Expenditure 4,193 4,395 4.8% 7,450 8,175 9.7%
Operating profit (EBDITA) 575 1,006 74.9% 1,075 1,647 53.1%
EBDITA margin (%) 12.1% 18.6%   12.6% 16.8%  
Other income 201 79 -61.0% 243 152 -37.8%
Interest (net) 7 21 205.8% 14 30 119.3%
Depreciation 45 50 9.5% 88 98 11.3%
Profit before tax 724 1,014 40.0% 1,218 1,671 37.2%
Tax 221 354 60.4% 393 597 51.7%
Profit after tax/(loss) 503 659 31.0% 825 1,075 30.3%
Net profit margin (%) 10.6% 12.2%   9.7% 10.9%  
No. of shares (m) 123.6 123.6   123.6 123.6  
Diluted earnings per share (Rs)* 16.3 21.3   13.3 17.4  
Price to earnings ratio (x)**         18.8  
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
Castrol India is the largest private sector MNC engaged in the production and marketing of lubricants. Castrol is part of the BP group Worldwide. The company’s business consists two main segments, automotive and industrial lubricants. Castrol is a market leader in the automotive segment. It markets its automotive lubricants under two brand names- 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 their own retail outlets) has put pressure on the company’s market share in recent times. To mitigate the impact of the same, the company has entered into an agreement with Essar Oil and Reliance to market its lubricants through their retail outlets.

What has driven the performance in 2QCY07?
Increased realisations: Topline growth of 13.3% YoY during the quarter was driven by improved realisations. It should be remembered that since CY06, the company has been resorting to price hikes to offset the increasing cost of base oil. Topline growth despite price hikes is a testimony to the strength of the Castrol brand.

Price hikes on the one hand and advertising expenses on the other indicates clearly the management’s strategy to work on its brand rather than succumb to the pressure to commoditize their offerings. It should be noted that advertising expenses have also gone up by 58.8% YoY for 2QCY07 and by 50.4% for 1HCY07 YoY.

The company is likely to become increasingly dependent on advertising going forward.

Cost break up…
(Rs m) 2QCY06 2QCY07 Change 1HCY06 1HCY07 Change
Raw materials 3,193 3,158 -1.1% 5,647 5,945 5.3%
% sales 67.0% 58.5%   66.2% 60.5%  
Staff cost 200 214 7.4% 344 405 18.0%
% sales 4.2% 4.0%   4.0% 4.1%  
Advertisement 176 280 58.8% 297 446 50.4%
% sales 3.3% 5.2%   3.5% 4.5%  
Carriage, Insurance & Freight 180 203 12.5% 331 366 10.4%
% sales 3.3% 3.8%   3.9% 3.7%  
Other expenditure 444 540 21.5% 832 1,013 21.8%
% sales 9.3% 10.0%   9.8% 10.3%  

Significantly improved margins: Despite the upward movement of crude of late, the company has been able to reduce raw material costs by 1.1% during the quarter on a YoY basis. Infact, since the company imports a substantial portion of its raw material needs (40% in CY06), the appreciation in rupee has helped offset the rise in crude oil prices.

Any decline in raw material costs, which constituted 67% of sales in 2QCY06, has a strong effect on the margins. Hence a 1.1% reduction went a long way in boosting the EBITDA margin by 650 basis points.

The largest increase was in advertisement costs, which strengthens the brand and potentially gives rise to pricing power. However, there’s only so much advertising can do - cutthroat competition often negates the effect of advertising, as many FMCG companies know to their dismay.

What to expect?
At the current price of Rs 273, the stock trades at a price to earnings multiple of 19 times trailing twelve month earnings. There are signs of reversal in the declining operating margins, signaling some control over higher input costs and competition. However, 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.

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