India’ second largest lubricant manufacturer Castrol India has in the last five years grown its cash profits by a robust 31 per cent. This debt-free company has also earned an average return on capital employed (RoCE) of 98 per cent over the same period.
India’s lubricant market is estimated to be about 2.5 million tonnes in size, of which automotive lubes account for 60 per cent or about 1.5 million tonnes. Castrol has an estimated market share of 17 per cent in this market (Kotak Securities’ estimate). Automotive lubricants account for around 85 per cent of the company’s revenue while the balance is accounted for by industrial and marine lubes.
Current outlook and concerns
Technological advancements are regarded as a positive for any industry. For lubricant companies like Castrol, they pose a dilemma. Technological improvements to create higher performance — longer lasting lubes — have had the unintended consequence of reducing lubricant sales volumes. The industry’s sales volume has been growing at a mere 3-4 per cent annually. In 2007, for instance, domestic lube oil consumption stood at 2.3 million tonnes. Three years later, consumption had improved only marginally to 2.5 million tonnes. Castrol’s sales volume has grown at a CAGR of 0.58 per cent between 2002-2010. Over the last five years, volumes have declined — from 226 million litres in CY06 to 209 litres in CY10. It has countered this through price increases, which have helped it post a revenue growth of 12 per cent over this period.
Castrol also has to contend with a deluge of lubricant brands — more than 35 — operating in the Indian market. These include IOCL, the country’s largest player, with its Servo brand. Others include such names as Total, Gulf, Shell and Veedol.
Castrol’s dependence on lube oil base stocks (LOBS), a derivative of crude, is also a matter of concern. Base oils and additives constitute 65-70 per cent of total production cost of lubricant manufacturers. Higher crude prices directly impact Castrol’s margins. From accounting for 47.96 per cent of raw material cost in CY09, LOBS accounted for 53 per cent in CY11. Consequently Ebitda margins are expected to decline from 26.2 per cent (CY09) to 25.79 per cent in CY11 (Kotak estimate).
Castrol has been able to hike prices in tandem with the rise in crude prices due to the pricing power it commands. It is also pushing sales of its high-efficiency synthetic oil-based lubricants which, not being dependent on crude, can help improve margins. So far the company has managed to beat the odds. In spite of a low revenue growth rate (12 per cent), cost tightening has helped boost cash profits 31 per cent CAGR in five years.
Valuation In spite of the industry dynamics, Castrol’s strong brand franchise, healthy cash flows and balance sheet, high RoCE and a high dividend paying track record have all helped the company command a premium in the stock market. At the current P/E of 21.9, Castrol trades at around 13 per cent premium to its median P/E of 18.95. Its earnings per share (EPS) has grown at a CAGR of 27 per cent over the last five years. This translates into an attractive PEG ratio of 0.78. A high dividend yield of 3.59 per cent provides a cushion against the prevailing volatility in the stock market and also enhances its total return. Buy the stock with a time horizon of three to five years.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
