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Castrol: Agony Continues… - Views on News from Equitymaster

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Castrol: Agony Continues…
Oct 23, 2006

Performance summary
Castrol, the automotive lubricant major, has declared its results for third quarter ended September 2006 (December ending fiscal). Topline registered a growth of 26% for the quarter while the growth during 9mCY06 was bit lower at 21%. High price of base oil and additives coupled with increased cost of packaging and brand building impacted operating margins in 3QCY06. Significant increase in the other income (49% YoY for 3QCY06) along with reduction in depreciation and interest cost could not salvage the fall in profit before tax.

Financial snapshot…
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9MCY06 Change
Net sales 3,341 4,193 26% 10,492 12,719 21%
Expenditure 2806 3,780 35% 8,746 11,230 28%
Operating profit(EBDITA) 535 413 -23% 1,746.4 1,488.5 -15%
EBDITA margins(%) 16.0% 9.9%   16.6% 11.7%  
Other income 35 52 49% 119 141 19%
Interest expenses 10 6 -39% 26 20 -24%
Depreciation 48 45 -5% 147 133 -9%
Profit before tax 512 414 -19% 1,693 1,477 -13%
Extraordinary income - - 0% - 154 0%
Tax 176 75 -58% 543 467.7 -14%
Profit after Tax 336 340 1% 1,151 1,164 1%
Net profit margin(%) 10.1% 8.1%   11.0% 9.2%  
No.of shares(m) 123.6 123.6   123.6 123.6  
Diluted earnings per share 2.72 2.75   9.3 9.4  
Price to earning ratio.(x)*         21.1  
(*trailing twelve month earnings, excluding extraordinary income)

What is 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.

What has driven performance in 3QCY06?
Realisation drives topline: Topline registered a growth of 26% YoY and 21% YoY for 3QCY06 and 9mCY06 respectively. Given the fact that the volumes growth in the sector spans in the range of early single digit, it can be inferred that the increased realisation were prime driver for the higher sales growth. Increased realisation is largely because of higher input cost and does not reflect the bargaining power of the company with the customers.

Higher cost dents margins: Cost of the basic raw material in the form of base oil and additives has reached historical highs. Refinery capacity shortages across the globe coupled with increase in the demand of the petrol and diesel has made production of higher value products (like motor spirits (petrol), diesel and LPG more remunerative for the refineries. Thus, the refineries worldwide have shifted from the production of base oil to production of high value products. This led to significant rise in the price of base oil, as the product crack widened. Castrol largely fulfills its raw material requirements through imports as compared to the integrated peers like HPCL, BPCL and IOC. This puts the company at a disadvantage vis-à-vis its peers. However, product prices were hiked to combat higher input costs. Thus, higher prices vis-à-vis its peers, increased competition and lower growth rate of the industry has forced Castrol to hike its adspend. The same is reflected from the increase in advertisement expenditure (23% YoY for 3QCY06).

Expenditure break-up…
(Rs m) 3QCY05 3QCY06 Change 9mCY05 9MCY06 Change
Consumption of raw material 1,949.9 2,860.8 46.7% 6,157.00 8,508.00 38.2%
as a % of sales 58.4% 68.2%   58.7% 66.9%  
Staff Cost 165.1 178.3 8.0% 490.20 521.90 6.5%
as a % of sales 4.9% 4.3%   4.7% 4.1%  
Advertisement Cost 140.3 189.4 35.0% 435.9 486.0 11.5%
as a % of sales 4.2% 4.5%   4.2% 3.8%  
Freight cost 152.7 161.7 5.9% 455.8 492.9 8.1%
as a % of sales 4.6% 3.9%   4.3% 3.9%  
Other expenditure 398.0 389.9 -2.0% 1,206.90 1,221.50 1.2%
as a % of sales 11.9% 9.3%   11.5% 9.6%  

Lower tax outgo safeguards net profit: Other income (1.2% of the net sales) witnessed a spike of 49% in the quarter, while the same grew by 19% in the 9mCY06. Interest expenditure also reduced over the period. However, the same did not have a significant impact due to low leverage of the firm.

Performance over the recent past…
(Rs m) 2QCY05 3QCY05 4QCY05 1QCY06 2QCY06 3QCY06
Sales growth(YoY) 9.6% 10.1% 8.1% 17.5% 20.6% 25.5%
Operating profit margins 18.9% 16.0% 9.7% 13.3% 12.1% 9.9%
Net profit margins 12.5% 10.1% 8.3% 8.6% 10.6% 8.1%
Net profit growth(YoY) 5.0% 8.2% 41.5% 0.6% 1.7% 1.1%

What to expect?
At the current price of Rs 230, the stock trades at a price to earnings multiple of 21 times trailing twelve month earnings (excluding the extraordinary income). The growth rate in the automotive segment (major contributor to Castrol topline) is likely to be slower in the future on the back of improved technologies (leading to higher drain life). However, with the advancement of vehicle engine technology and increasing customer orientation of OEMs, the warranty stage is becoming increasingly important, as car/motorcycle owners prefer to service their vehicles at OEM franchised workshops. This has led to a shift in lubricant demand for personal vehicles from petrol pumps to workshops and the transition is likely to sustain itself, as sales of lubricants from petrol pumps is set to reduce. This is going to benefit Castrol, as the same sells its products through ‘bazaar segment’. Taking on the initiative, Castrol has rolled out ‘Castrol Bikezone’. All said and done, operating margins have declined over the last 10 years (from the highs of over 20% to sub 10% levels) signaling higher input costs and competition. That said, the recent decline in crude prices should bring some respite to the company. Overall, we continue to maintain a negative view on the stock.

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