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Castrol: Cushioned by costs
Oct 25, 2007

Performance summary
  • Topline increases by 3% YoY during 3QCY07 hampered by lower volumes.

  • EBITDA margins expand to 19%, from 10% in 3QCY06. Favorable exchange rate and firm base oil prices also helps matters.

  • Other income rises by 64% YoY during the quarter.

  • Bottomline registers a growth of 60% YoY owing to operating margin expansion and higher other income.

  • Topline and bottomline grow 11% YoY and 39% YoY respectively in 9mCY07.

Financial snapshot
(Rs m) 3QCY06 3QCY07 Change 9mCY06 9mCY07 Change
Net sales 4,193 4,311 2.8% 12,719 14,133 11.1%
Expenditure 3,780 3,481 -7.9% 11,230 11,656 3.8%
Operating profit (EBDITA) 413 830 100.9% 1,489 2,477 66.4%
EBDITA margin (%) 9.9% 19.3%   11.7% 17.5%  
Other income 52 86 64.2% 296 237 -19.7%
Interest 6 7 16.7% 20 37 87.7%
Depreciation 45 51 13.5% 133 149 12.0%
Profit before tax 414 858 107.1% 1,632 2,529 55.0%
Tax 75 315 323.2% 468 912 95.0%
Profit after tax/(loss) 339.60 542.20 59.7% 1,164 1,617 38.9%
Net profit margin (%) 8.1% 12.6%   9.2% 11.4%  
No. of shares (m)         123.6  
Diluted earnings per share (Rs)*         16.16  
Price to earnings ratio (x)*         17.4  
(* on trailing twelve months earnings)

What is the companyís 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 companyís 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 companyís 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. The company is also moving up the service value chain through service formats like Castrol BikeZone, a chain of franchised multi-bike servicing outlets spread across the country.

What has driven the performance in 3QCY07?
Sluggish topline: Topline growth of 3% YoY during the quarter was a result of sluggish volumes. It should be remembered that since CY06, the company has been resorting to price hikes to offset the increasing cost of base oil. Despite this, the company had been achieving topline growth on the strength of the Castrol brand and loyal patronage of its premium products by its customers, trade, workshops and original equipment manufacturers (OEMs). However, absent any price hikes during the quarter, momentum weakened and this resulted in lower topline growth in 3QCY07.

In the past, price hikes on the one hand and advertising expenses on the other were part of the managementís strategy to work on its brand rather than succumb to the pressure of commoditising their offerings. Advertising expenses have remained flat for 3QCY07 on the back of a low growth in topline as the management didnít want the same to further put pressure on profitability.

Cost break up
(Rs m) 3QCY06 3QCY07 Change 9mCY06 9mCY07 Change
Raw materials 2,861 2,364 -17.4% 8,508 8,309 -2.3%
% sales 68.2% 54.8%   66.9% 58.8%  
Staff cost 178 249 39.6% 522 654 25.3%
% sales 4.3% 5.8%   4.1% 4.6%  
Advertising cost 189 190 0.1% 486 636 30.8%
% sales 4.5% 4.4%   3.8% 4.5%  
Carriage, Insurance & Freight 162 130 -19.9% 493 495 0.5%
% sales 3.9% 3.0%   3.9% 3.5%  
Other expenditure 390 549 40.8% 1,222 1,562 27.9%
% sales 9.3% 12.7%   9.6% 11.1%  
Total cost 3,780 3,481 -7.9% 11,230 11,656 3.8%
% sales 90.1% 80.7%   88.3% 82.5%  

Significantly improved margins: Despite the upward movement of crude, the company has been able to reduce raw material costs by 17.4% during the quarter on a YoY basis. This could be attributed to steady prices of the base oil (key raw material for lubricants) as attractive prices in the recent past forced refiners to increase their output of base oil. In fact, since the company imports a substantial portion of its raw material needs (40% in CY06), the appreciation in rupee has helped it contain raw material costs in a big way. Any decline in raw material costs, which constituted 68% of sales in 3QCY06, has a strong effect on the margins. Hence a 17% reduction went a long way in boosting the EBITDA margin by almost 10%.

Cost was kept in check even on the advertisement front. It may be noted that the company is a prominent advertiser and advertising is discretionary in nature. Hence Castrol checked its expenses on this count in the face of sluggish topline growth.

Operating margins were further helped by the 20% decline in carriage, insurance & freight costs in 3QCY07 on a YoY basis.

What to expect?
The company has improved operating margins this quarter, signaling its ability to maintain growth. The company is entering into strategic alliances with OEM partners like Tata commercial vehicles division, Tata passenger cars, Mahindra and Mahindra, Ford, JCB and L&T. It has also entered into a new partnership agreement with Volvo cars who have just launched their vehicles in India. Castrol BikeZone is also set for fast expansion.

At the current price of Rs 281, the stock trades at a price to earnings multiple of 17 times trailing twelve month earnings. Considering the dynamics and competitive landscape of the Indian lubricant industry, we believe that the valuations reflect the companyís growth prospects in the medium term. Hence we suggest investors to exercise caution at the current juncture.

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