Institutional Equities - The Smart Investorsmartinvestor.business-standard.com/BSCMS/PDF/castrol india_31121… · Castrol India has so far ably defended its market share in the lube

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Institutional Equities

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Reuters: CAST.BO; Bloomberg: CSTRL IN

Castrol India

Geared For Growth Castrol India has so far ably defended its market share in the lube oil industry despite its premium product offerings by leveraging on its strong brand. We view the street’s concerns over continued pressure on volume/market share as overdone as we expect: (1) Stagnancy in the industrial segment to be offset by robust retail demand, thus keeping overall volume stable, and (2) Pressure on margins in the coming quarters to ease with a judicious product mix. We expect volume CAGR at 1.9% over CY11-CY14E driven by retail/workshop channel, while adjustment in product pricing and launch of low-premium products are likely to help it recapture market share. We have assigned a Buy rating to Castrol India with a target price of Rs349 using weighted average methodology. Renewed focus to capture market share: Our interaction with industry experts/dealers/mechanics/lube companies revealed that the company has regained market share at ~22% in September 2012 after shedding almost 200bps last year as a result of its premium product offerings (premium touched 30%-35%). The gain is on account of: (1) Premium pricing versus rivals stabilising in the band of 20%-25%, (2) Castrol being relatively immune to cost pressures, considering the company’s positioning as price leader, (3) Launch of low-premium products like Activ Go for bikes and RX Super for commercial vehicles to mark its presence in the mid-size segment. Volume growth, palpable signs of recovery visible: We expect volume to grow 2.4%/3.4% in CY13E/CY14E, respectively, after posting negative growth in CY11/CY12E. We expect it to report volume of 208mn/213mn/220mn litres in CY12E/CY13E/CY14E, registering volume CAGR of 1.9% over CY11-CY14E compared to 0.5% likely over CY09-CY12E. We believe volume growth would be driven by: (1) Rising exposure of the company towards the personal mobility segment, (2) Retail/workshop volume growth (on YTD basis volume grew 7% though industrial volume declined), (3) The company’s renewed focus on capturing market share by offering low-premium products, (4) Growing penetration of Hub & Spoke model in commercial vehicles, where volume growth in light commercial vehicles (LCVs) arrests the decline in volume from heavy commercial vehicles (HCVs), and (5) Increased focus on small towns and rural areas, a key growth market in the personal mobility space, in conjunction with its plan to capture the business from the tractor segment. Assign Buy rating to the stock: We have assigned a Buy rating to the stock with a target price of Rs349 using weighted average methodology to capture medium to long-term potential. We assign 60% weight to PE and a 20% weight each to DCF/Gordon dividend discount methodology. We believe a PE multiple of 30xCY14E earnings (two year average of 27x) will sustain to reflect: (1) Volume CAGR of 1.9% over CY11-CY14E compared to 0.5% over CY09-CY11, (2) Expansion in margins of 300bps over CY12E-CY14E, (3) The company regaining market share with the launch of low-premium products and (4) MNC parentage aiding the launch of innovative products to compete with Shell and Petronas (5) Company’s price leadership position (6) Earnings growth at 13%/16% in CY13/14, which would result in RoE to improve to 72.7%/78.8% compared

to 69.5% in CY12E.

BUY

Sector: Oil & Gas

CMP: Rs298

Target Price: Rs349

Upside: 17%

Ashutosh B [email protected] +91 22 3926 8110

Vivek Sarin [email protected] +91 22 3926 8176

Key Data

Current Shares O/S (mn) 494.6

Mkt Cap (Rsbn/US$bn) 146.3/2.7

52 Wk H / L (Rs) 338/194

Daily Vol. (3M NSE Avg.) 207,741

Shareholding (%) 1QCY12 2QCY12 3QCY12

Promoter 71.0 71.0 71.0

FII 7.8 7.9 8.1

DII 7.0 7.1 6.5

Corporate 1.0 0.9 1.0

General public 13.2 13.0 13.4

One Year Indexed Stock Performance

Price Performance (%)

1 M 6 M 1 Yr

Castrol India (1.2) 15.4 47.1

Nifty Index 2.5 14.2 23.6

Source: Bloomberg

Y/E December (Rsmn) CY10 CY11 CY12E CY13E CY14E

Net sales 27,348 29,818 31,968 34,439 35,721 YoY (% ) 18.0 9.0 7.2 7.7 3.7 EBITDA 7,251 6,584 6,013 6,742 7,793 EBITDA margin (%) 26.5 22.1 18.8 19.6 21.8 Net profit 4,903 4,811 4,359 4,920 5,701 EPS 9.9 9.7 8.8 9.9 11.5 RoAE (%) 93.5 83.1 69.5 72.7 78.8 RoACE (%) 93.8 83.3 69.7 72.9 79.0 P/E (x) 30.1 30.6 33.8 30.0 25.9

Source: Company, Nirmal Bang Institutional Equities Research

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CASTROL INDIA NSE S&P CNX NIFTY INDEX

31 December 2012


2 ONGC Castrol India

Gross margin spread to rise: We expect the gross margin spread at Rs62/Rs66/Rs70 per litre in CY12E/CY13E/CY14E, respectively, compared to Rs62/litre in CY10 and CY11. The company has shown continuous uptrend in gross margin on per litre basis since 1996, except for one instance in CY02. We see gross margin rising due to: (1) Change in the product mix towards synthetic/semi-synthetic engine oils, (2) Launch of ‘Professional’ range of synthetic engine oil priced 25%-30% higher than conventional products, and (3) Most new cars/bikes/commercial vehicles are based on synthetic/semi-synthetic technology base.

Earnings growth to turn positive: We expect earnings growth of 13%/16% in CY13E/CY14E, respectively, after posting negative growth over the past two years and RoE to improve to 72%/78% in CY13E/CY14E respectively compared to 69.5% in CY12E. The management has reiterated its stand to defend margins in the range of 23%-24% in a volatile foreign exchange/crude oil situation and so we expect EBITDA margin at 20%/22% in CY13E/CY14E, respectively. We expect margin to improve despite venturing into low premium products on account of: (1) Increasing proportion of sales from higher premium synthetic/semi-synthetic products and (2) Aggression in sale of low priced products only in selected pockets which have witnessed increased competitive intensity. The consensus EPS estimate for CY13 earnings stands at Rs10.94(Range lies between Rs9.1-11)

Exhibit 1: One-year forward P/E Exhibit 2: Three-year moving average P/E

Source: Bloomberg, Nirmal Bang Institutional Equities Research Source: Bloomberg, Nirmal Bang Institutional Equities Research

Exhibit 3: One-year forward P/BV Exhibit 4: Three-year moving average P/BV


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Investment Arguments

Renewed focus to capture market share

Castrol India adopted a marketing strategy to exit from low-profit segments since 2005, reducing supply, particularly to Indian Railways and other government departments, in order to focus on high-margin business. The company’s focus lies more on value rather than volume to drive earnings and expand margins. This has led the gross margin to expand to Rs62.0/litre in CY11 from Rs26.1/litre in CY06. The company’s understanding on price elasticity (till the premium on its products remains in the range of 20%-25% it maintains market share of ~22%-23%, but reneges it once it crosses 30%-35%) bodes well for it to deploy a well balanced pricing strategy.

Our interaction with industry experts/dealers/automobile mechanics indicated the company regained market share at ~22% in September 2012 after shedding almost 200bps in the past 18 months after the premium pricing level on its products touched 30%-35%. The company is gaining market share on account of: (1) Price premium moderating in the band of 20%-25%, (2) Competitors increasing product pricing pressure in the wake of rising costs and (3) The company launching low-premium products like Activ Go for bikes and RX Super for commercial vehicles to mark its presence at the top-end of mid-sized product segment.

Castrol India’s market share in bazaar trade remained stable in the past two quarters at 21.9% (touching a low of 21.0% in 3QCY11) after the company revised its pricing strategy and renewed focus on capturing lost market share. It has further decided to revisit it whenever the price premium compared to rivals’ products tops 25%. We believe the 20%-25% premium pricing strategy will continue to work despite rising competition (there are ~66 organised companies in the fray in the lubricant market) on account of the following: (1) Unlike fast moving consumer goods (FMCG), most consumers of engine oils face downtime costs if their equipment/machinery remain idle or work less efficiently, and (2) Downtime costs risk make commercial vehicle, tractor and construction equipment owners switch to reliable and branded engine oils and also be more willing to pay a higher price for an established brand.

Castrol India, as of end September 2012 quarter, had volume market share of 21.9% and revenue market share of 26.0%. Revenue market share of Castrol India remained in the range of 25%-27% from 4QCY09 to 3QCY12 and almost constant at 26% over the past four quarters. Castrol India maintaining its volume market share and revenue market share shows: (1) The company maintaining volume market share in a declining volume growth environment indicates that lower volume is an industry-wide phenomenon following the change in engine technology and smaller sump size, and (2) The company plays a role in deciding the pricing regime of the industry alongwith the margins of its competitors.

We believe the market share of Castrol India will improve from the current level after it launched low-premium products to grab volume in the motorcycle and commercial vehicle space. In the motorcycle segment, the company launched Activ Go and in the commercial vehicle segment RX Super, priced close to that of its nearest competitor. The strategy to launch these products is to mark their presence at the top end of the mid-tier segment to grab market share and maintain brand positioning.

Exhibit 5: Market share by volume

Source: Industry, Nirmal Bang Institutional Equities Research

24 23 21 23 23 23 21 21 21 22 22 22

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BPCL Castrol Gulf Oil Savita Oil Shell Tide Water Oil Total



Exhibit 6: Market share by value


Exhibit 7: Dealer/mechanic survey*

Customer awareness promotes sales of Castrol’s products

Castrol advertisements more focused and thus attract customer attention than rivals

Sustained advertisement campaigns remain critical to drive retail sales

Customer seeking efficiency/quality prefer buying Castrol products

Customer perception on quality assurance is most critical for purchase decision

Activ 4T (2W), GTX (passenger car) and CRB(CV) are top-selling products of Castrol

Volume growth quite buoyant in two-wheeler and passenger car segments, but subdued in commercial vehicle space

Company’s experiment of recommending Magnatec has helped taxi-owners

Company’s terms/conditions for credit period/cash discounts tighter than those of rivals

Discount coupons critical for purchase recommendation from small automobile mechanics

Credit period of Castrol 30 days compared to 45-60 days of competitors

Castrol dealers expect 5%-6% volume growth, lower than what dealers of Veedol/Valvoline/Savita oil expect

Tractor volume growth picks up from October 2012

Shell/Petronas offering more discounts/favourable credit conditions to grab market share

Source: Nirmal Bang Institutional Equities Research

*Note: We conducted one to one survey conducted in vicinity of Parel, Dadar, Mahim, Thane, Wadala; Telephonic survey conducted in Delhi, Jodhpur, Aligarh

Exhibit 8: Castrol India’s volume growth guidance

Year Volume market share Industry volume growth (%) Volume guidance for next year (%)

(%) Lower end Upper end Lower end Upper end

2011 22 2 3 3 4

2010 20 3 4 3 4

2009 20 1 2 - -

2008 21 (1) (2) - -

2007 21 - >3 2 3

Source: Annual reports, Nirmal Bang Institutional Equities Research

Exhibit 9: Price comparision

Four-wheeler Grade Price (Rs/litre)

Pennzoil 15W40 242

Veedol 15W40 211

Servo (IOC) 15W40 267

MAK(HPCL) 15W40 230

Castrol 15W40 294

Apar Chemicals 15W40 269

Lavas(local) 15W40 180

Mobil 15W40 208


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BPCL Castrol Gulf Oil Savita Oil Shell Tide Water Oil Total



Exhibit 10: Price comparision

Two-wheeler Grade Price (Rs/litre)

Veedol 20W40 245

Castrol 20W40 266

Racer4(HPCL) 20W40 250

Servo (IOC) 20W40 255

Apar Chemicals 20W40 242

BPCL 20W40 251


Exhibit 11: Prices of Castrol India’s key products (landed prices at dealer-end)

Four-wheeler 210 litre 50 litre 7.5 litre 5 litre 4 litre 3.5 litre 3 litre 2.5 litre 1 litre 500 ml

Castrol Magnatec 70,640 17,969 - - 1,436 1,260 1,092 - - 186

Castrol Magnatec 5W-30 67,295 - - - 1,479 1,297 1,125 - - 190

GTX Petrol 53,252 12,561 - 1,334 1,067 900 801 - 269 137

GTX Diesel 49,424 - 2,029 1,355 1,089 - - - 294 -

Two-wheelers 210 litre 50 litre 20 litre 4 litre 1 litre 900 ml 800 ml 500 ml 350ml 40 ml

Active 4T 20W-40 49,332 11,746 4,757 - 235 220 - - - -

Active Go - 12,600 - - 216 198 - - - -

Heavy vehicles 210 litre 50 litre 20 litre 15 litre 10 litre 7.5 litre 5 litre 3 litre 1 litre 500 ml

CRB Turbo 54,999 13,250 - 4,064 2,747 2,070 1,413 847 295 -

CRB Plus 54,008 13,005 5,198 - 2,646 1,991 1,350 818 272 141

Diesel Oil SAE-40 52,752 12,744 5,152 - - 1,951 1,325 - 269 -


Volume growth, palpable signs of recovery visible

We expect volume to grow 2.4%/3.4% in CY13E/CY14E after posting negative volume growth in CY11/CY12E. We have projected the company to report volume of 208mn/213n/220mn litres in CY12E/CY13E/CY14E, respectively. We expect volume CAGR at 1.9% over CY11-CY14E compared to 0.43% over CY09-CY12E.

Exhibit 12: Volume ramp-up Exhibit 13: Volume CAGR

Source: Company, Nirmal Bang Institutional Equities Research Source: Company, Nirmal Bang Institutional Equities Research

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(mnltrs)(mnltrs)

Lubricants Total volume Traded items (RHS) (4)

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CY06 CY07 CY08 CY09 CY10 CY11 CY12E CY13E CY14E CY15E

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Exhibit 14: Quarterly volume growth Exhibit 15: Annual volume growth


Of the last seven years, Castrol India reported decline in volume growth for five years, except for CY05 and CY10. Even in CY12E, volume is expected to be marginally negative at 207.6mn litres (implying a decline of 0.5% YoY). Industry volume growth has been lower, in the range of 3%-4% since CY04 due to the following reasons: (1) Change in engine technology, which led to lower lubricant consumption and higher drain interval, and (2) Reduction in sump size of engines. The consumption of lube oil can be gauged from the fact that drain interval of trucks/buses has elongated to 36,000km from 18,000km in the last six-seven years, which effectively tapered down volume growth although the decline was arrested by robust growth in light commercial vehicles.

We expect the volume in India’s lubricant market to post a CAGR of 3% over CY12-CY15E at 2.05mt from 1.85mt on the back of: (1) Commercial vehicles expected to show a CAGR of 9% over FY12-FY15E, (2) Passenger cars likely to post a CAGR of 7% over FY12-FY15E, (3) Tractors expected to post a CAGR of 12% over FY12-FY15E factoring in economic revival in the second-half of FY14, interest rates likely to ease from FY14 and likely softness in petrol prices.

We have projected volume CAGR of 1.9% over CY12E-CY14E at 222mn litres from 207.6mn litres in CY12E. The company’s management expects lubricant volume to post a CAGR of 3%-4% over the next three years, 1.0%-1.5% higher than the industry’s growth. We have assumed Castrol India’s volume to grow slower than the industry average with competition getting tougher from Shell and Petronas. Shell with a market share of ~6% aims to touch its global market share level of ~12% in India. Petronas has initiated an aggressive marketing strategy for dealers to push its products following its aim of achieving a dominant position in emerging markets.

We expect Castrol India to achieve volume of 207mn/213mn/222mn litres in CY12E/CY13E/CY14E, respectively. We believe the volume growth would be driven by: (1) Rising exposure of the company to the personal mobility segment (on YTD basis, retail/workshop volume grew 7% offseting industrial volume decline), (2) The company’s renewed focus to capture market share by offering low-premium products, (3) Growing penetration of Hub & Spoke model in commercial vehicles, where volume growth in LCVs will arrest the decline in volume from HCVs, and (4) Increased focus on small towns and rural areas, a key growth market in the personal mobility space, alongwith its plan to increase its footprint in the tractor segment business.

In times of slower economic growth (reflecting on lower volume from the industrial sector viz. mining, construction, off-highway equipment, marine etc), the company is increasing exposure towards the personal mobility segment (comprising motorcycles/passenger cars) to mitigate the risk of slowing commercial vehicle segment, which historically has been a key segment for the company. Passenger cars and motorcycles currently constitute ~35% of total sales volume of Castrol India and diesel engines ~40% of sales volume. The company has been increasing its efforts to tap further potential from passenger cars and motorcycles by means of advertising campaign and interaction with motor mechanics. The company has devised a three-pronged exercise to further penetrate the personal mobility segment comprising: (1) Studying the price elasticity of demand for its products so as to decide the quantum of cost increases to be passed on to consumers, (2) Price elasticity has been lower as the savings on switching to cheaper brands as a percentage of total servicing cost is negligible, (3) Training and financial support to automobile mechanics who are key promoters of the company’s products.

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In order to regain focus on volume rather value and reclaim lost market share, the company adopted a strategy to launch products at the top range of the mid-tier pricing segment, where product premium is 10%-15% higher than rivals compared to 20%-25% on other products. Castrol India has launched Activ Go for motorcycles and RX Super for commercial vehicles.

The company believes the growth in organised retail and the evolving Hub & Spoke model would lead to higher growth in the LCV segment in the medium term, offsetting the decline in the M/HCV segment. As per CRISIL Research estimate, LCV volume is likely to grow 13%-15% in FY13E, although the M/HCV segment is expected to show a decline of 12% to 15% in the same year. We believe the LCV/MHCV ratio is structurally low in India and the segment is least impacted by economic downturn, as it is still under-penetrated.

Exhibit 16: Drain interval of vehicles and annual engine oil requirements

Vehicle type Drain interval

(km) Sump size

(litre) Annual distance

(km) Frequency of

replacement (x) Engine oil requirement

(litre/year)

Old CV 18,000 20.0 70,000 3.9 77.8

New CV 36,000 15.0 100,000 2.8 41.7

LCV 8,000 7.5 40,000 5.0 37.5

Passenger car 12,000 4.0 12,000 1.0 4.0

Motorcycle 3,000 1.0 4,000 1.3 1.3


Exhibit 17: LCV-MHCV ratio structurally low in India Exhibit 18: Sub-one tonne vehicle, pick-up truck gain share

Source: Crisil Research Source: Crisil Research

Exhibit 19: Cumulative vehicles sales volume


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Exhibit 20: Castrol India’s sales volume by application Exhibit 21: Castrol India’s sales by engine configuration

Source: Nirmal Bang Institutional Equities Research Source: Nirmal Bang Institutional Equities Research

Exhibit 22: Lubricant market - consumption pattern Exhibit 23: Lubricant market - point of sales


Exhibit 24: Management commentary on volume growth

2011 Market likely to witness volume growth of 2-3% on demand driven by four-stroke motorcyles, passenger cars

Market likely to grow by around 3%-4% in volume terms in 2012E, two-wheeler/Passenger cars may see sales at 15mn units in the next four years

2010 Market expected to witness volume growth of 3%-4%

2009 Lubricant industry expected to grow 1%-2%, market to see volume growth after initial no-growth projection

2008

Overall market to shrink by about 1%-2%, oil drain interval of CVs doubles in 2006

Emergence of semi-synthetic and synthetic oil recommended by passenger car OEMs.

Oil drain and synthetic oil expected to have significant impact on volume in automotive lubricants

2007

Tata Motors introduces new oil drain specifications for H&MCV, lubricant market volume growth seen over 3%

Engine oil drain interval doubles to 36,000km and transmission oil drain intervals up at 72,000km

Drain interval to double, OEM dealership volume of CVs is 50% of current volume, projected growth would be around 2%-3% in volume terms

2006 Lubricant market is expected to grow by around 3%.

Source: Annual reports, Nirmal Bang Institutional Equities Research

The exhibit above elucidates the management’s view of tepid volume growth that it has been expecting over the years. This line of commentary is in sync with our view of moderating industry-wide volume growth due to technology advancement.

Exhibit 25: Declining trend in lube consumption more visible in developed markets

Year Consumption

(mmt) Asia Pacific &

RoW (mmt) North/South

America (mmt) Europe

(mmt) Asia Pacific &

RoW (%) North/South America (%)

Europe (%)

2011 35.1 18.3 9.8 7.0 52.1 27.9 19.9

2010 34.5 17.6 9.7 7.2 51.0 28.9 20.9

2009 32.2 16.7 8.7 6.8 51.9 27.0 21.1

2008 36.0 17.6 10.1 8.3 48.9 28.1 23.1

2007 37.1 16.3 11.1 9.7 43.9 29.9 26.1

Source: Fuchs Lubricants, Nirmal Bang Institutional Equities Research

Industrial/ Marine, 14

Off highway/ Industrial/ Firstfill

OEM, 10

Retail/ Workshop, 76

Diesel, 40

Motorcyle, 20

Passenger car, 15

Others, 25

Commercial vehicles, 62

Passenger cars, 5

Tractors, 13

Two-wheeler, 10

Three-wheeler, 3

Genset, 2Agriculture pumps,

5

Repair shop/local mechanic, 53

Local lube shop, 22

Workshop, 15

Others, 10



Exhibit 26: Competition perception on growth

Gulf Oil

Overall volume growth of 2-3% in 2013

Bazaar market segment growth expected to be 5%-6% in 2013

Focus on new generation diesel oil and motorcycle segment

Volume growth to be dominated by more price discounts/promotions

Plans to invest 15% of turnover to capture market share, plans to double market share in the next three years

Apar

Sees two-wheeler CAGR of 3.5-4.0% and 2.3%-2.4% CAGR in PCV in the next three-four years

CV volume would be driven by expansion in ultra light LCVs (below 3tn)

Total market size likely to grow 2.15mnt by 2015E, implying CAGR of 5.1%

Possibility of down-trading to grab market share.


Exhibit 27: Indian versus global lubricant market

Indian lubricant market Global lubricant market

One of most competitive lubricant markets

Estimates revenue size of Rs250bn, with total volume of 1.85mnt in FY12E

Current installed capacity of 2.2mmt

India is fifth largest lubricant market in the world after the US, China, Russia and Japan

Automotive sales contribute ~65% to total sales, with the rest being contributed by the industrial segment

India has about 1,200 manufacturers of lubricants out which 1,100 are SMEs

Semi-synthetic/synthetic both market currently having sales of Rs20bn

Demand in 2011 rose by just under 2% at 35.1 mmt

Global volume remains at around 1mmt (-2.5%) below the 2008 level

China and the US remain two largest markets, accounting for one-third of global consumption

Except China and India, no other country in top 20 lubricant countries exceeded their 2011 volumes level relative to 2008

Turkey witnessed highest increase in consumption among the 20 countries in 2011(up 6.7%)


Exhibit 28: Castrol India versus CV quarterly sales volume Exhibit 29: Castrol India versus CV annual sales volume


Exhibit 30: Sales growth across segments


(100)

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Gross margin spread to rise

We expect gross margin spread at Rs62/Rs66/Rs70 per litre in CY12E/CY13E/CY14E, respectively, compared to Rs62/litre in CY10/CY11. The company witnessed a continuous uptrend in gross margin on per litre basis from 1996, except for one instance in CY02. We see gross margin moving up on: (1) Change in product mix more towards synthetic/semi-synthetic engine oils, (2) Launch of ’Professional’ range of synthetic engine oil priced 25%-30% higher than conventional products, (3) The company playing a pivotal role in deciding the prices, being the market leader in bazaar trade with rivals taking cues on pricing from it, (4) Price hike of Rs5/litre in March-June 2012 to moderate the twin blow of rupee depreciation and high base oil prices, and (5) Most new cars/bikes/commercial vehicles being based on synthetic/semi-synthetic technology

We have projected gross margin at Rs62/Rs66/Rs70 per litre in CY12E/CY13E/CY14E, respectively on

the basis of our perception of the company’s ability to absorb rupee depreciation (our house call pegs rupee-US dollar exchange rate at Rs54.5/$/Rs55.5/$ for FY13E/FY14E, respectively). We expect EBITDA margin at 18.8%/19.6%/22.0% in CY12E/CY13E/CY14E, respectively largely due to the rupee factor.

Gross margin per litre will also be dependent on how prices of raw materials and additives pan out. For base oil, we have projected the prices using the regression model to base oil prices in US$/mt to Brent crude oil prices in US$/bbl. We have assumed Brent crude oil to average US$105/bbl in CY13E and US$100/bbl in CY14E, with intercept of 247.43, standard error of 5% and slope of 8.35 to arrive at a valuation of US$1,244/US$1,199 per mt for base oil in CY13E/CY14E, respectively.

Exhibit 31: Upcoming base oil plant maintenance/shutdowns

Refiner Location Duration Capacity (tn/yr)

Idemitsu Japan April – May 2013 305,000

GS Caltex South Korea January – February 2013 26,000 bpd

Petronas Malaysia January 2013 330000

HollyFrontier US December 2012 490000

Luberef Saudi Arabia December 2012 270000


Exhibit 32: Yearly gross spread Exhibit 33: Quarterly gross spread


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Exhibit 34: Cost trend Exhibit 35: Cost trend


Exhibit 36: Brent crude, base oil correlation Exhibit 37: Standard deviation-Base oil and crude oil


Exhibit 38: Spread-Base oil and crude oil Exhibit 39: Regression analysis-crude oil, base oil


The growing divergence between base oil and Brent crude highlighted in Exhibit 37 and Exhibit 38 is on account of an increase in the number of outages that base oil producing refineries witnessed in the current CY. This trend is also reflected in Exhibit 39 where the calculated standard error works out to ~16%. We foresee a correction in the coming year, with the standard error reverting to 5% as more units resume production. Consequently, the correlation portrayed in Exhibit 36 should also strengthen.

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Earnings growth to turn positive

We expect earnings growth of 13%/16% in CY13E/CY14E, respectively, after witnessing negative growth in the past two years and also RoE to improve to 73%/78% in CY13E/CY14E compared to 69% in CY12E. The management has reiterated its stand to defend the margins in the range of 23%-24% in a volatile exchange/crude oil situation and so we expect EBITDA margin at 20%/22% in CY13E/CY14E, respectively.

Exhibit 40: Revenue trend Exhibit 41: Profitability trend


Exhibit 42: EBITDA margin trend Exhibit 43: RoE trend


We assign a Buy rating to the stock

We have assigned a Buy rating to the stock with a target price of Rs349 using weighted average methodology to capture medium to long-term potential. We have given 60% weight to PE and a 20% weight each to discounted cash flow/Gordon dividend methodology(Cost of equity 11.5%, Beta 0.5, ERP

7%). We have assigned PE of 30xCY14E earnings (compared to two-year average of 27x) to reflect: (1) Volume CAGR of 1.9% over CY11-CY14E compared to 0.5% over CY09-CY11, (2) Margin expansion of 300bps likely over CY12E-CY14E,(3) Regaining market share via launch of low-premium products and readjustment of premium pricing (4) BP(British Petroleum) as parent would help company to launch most innovative product line to taken on competition and strengthen relationship with OEMs.

Exhibit 44: Castrol India valuation

Weighted average method for fair value computation

Weight (%) Value (Rs/share) Valuation methodology

PE 60 346 -Assigned PE multiple of 30x CY14 EPS

Gordon dividend discount 20 350 -Dividend growth in perpetuity at 3.0%, WACC at 11.5%

DCF value 20 360 -WACC at 11.5% and terminal growth at 3.0%

Weighted average - 349


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We believe Castrol India should sustain 30x multiple for CY14E due to the following reasons: (1) The company’s price leadership position in the industry, which helps reduce its vulnerability to pressure on margins, (2) Rise in gross margin/litre despite the fall in volume from 2000 onwards (except one instance in 2002), (3) Lubricant industry, which has been growing in low single-digit, is expected to grow at the same pace, which means the pivotal indicator of earnings quality should be sales per litre rather than absolute volume growth for Castrol India, (4) MNC parentage should reflect in higher PE multiple like that of Nestle India and GlaxoSmithKline Consumer, (5) Earnings growth of 13%/16% likely in CY13E/CY14E should result in RoE expansion to 73%/79%, respectively, compared to 69% in CY12E, (6) Volume growth in sport utility vehicle, multi-utility vehicle and sedan segments, key consumers of synthetic/semi-synthetic oils, would lead to improvement in gross margin, and (7) The company having one of the most extensive dealer networks with 270 dealers and 70,000 retail outlets and increased focus on the rural segment, which is likely to turn a major market by the end of 2015.

We believe the business model of lubricant market largely resembles that of the FMCG market in terms of distribution, sales pitch and a bit of price elasticity and so Castrol India deserves the valuation of FMCG companies.

Exhibit 45: Castrol India, FMCG companies’ business model

Refiner Castrol India FMCG companies

Brand premium Yes Yes

Wide dealer network Yes Yes

High dividend payout Yes Yes

High RoE Yes Yes

High advertising/sales promotion expenses Yes Yes

Dealer discount to drive sales Yes Yes


Castrol India stock currently trades at 30x/25.7x CY13E/CY14E earnings, respectively, and so we broadly see the company’s business model matching that of FMCG companies but the valuation multiple has remained at a discount for FMCG players in the absence of volume growth. As we stated earlier, volume for the lube industry has been muted on account of the change in engine technology and smaller sump size of engines, hence an important parameter to gauge the earning quality should be both market share in volume and revenue share.

In order to see how FMCG companies’ PE multiple has moved in times of lower/flat volume growth, we have tracked the PE multiples of Hindustan Unilever, ITC, Marico and Godrej Consumer Products with their respective volume growth. In case of each of the companies selected from our sample FMCG basket valuations seem to move in tandem with their respective volume growth. The trend is particularly visible since the beginning of CY12.

Exhibit 46: Hindustan Unilever price versus volume trend Exhibit 47: ITC price versus volume trend

Source: Industry, Nirmal Bang Institutional Equities Research Source: Industry, Nirmal Bang Institutional Equities Research

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Exhibit 48: Marico price versus volume trend Exhibit 49: Godrej Consumer price versus volume trend

Source: Industry, Nirmal Bang Institutional Equities Research Source: Industry, Nirmal Bang Institutional Equities Research

We have valued Castrol India on weighted average basis to capture the PE multiple potential in the medium term to long-term. We have given higher weight given to PE multiple to capture the medium-term impact of revival in volume growth, margin expansion and DCF/Gordon dividend discount to capture (free cash flow generation of Rs20,819mn likely over CY11-CY14E and dividend payout averaging 83% over CY03-CY11).

Exhibit 50: Castrol India’s three-year moving average


Exhibit 51: Volume growth sensitivity

Impact in CY13 (1.5)% 0.0% 1.5% 2.0% 2.5%

Revenue (Rsmn) 33,305 33,791 34,277 34,439 34,602

EBITDA (Rsmn) 6,342 6,513 6,685 6,742 6,799

PAT (Rsmn) 4,651 4,766 4,881 4,920 4,958

EPS (Rs/share) 9.40 9.63 9.86 9.94 10.02

Valuation (Rs/share) 332 339 347 349 352

Impact in CY14 (2.0)% 0.0% 2.0% 3.0% 4.0%

Revenue (Rsmn) 33,905 34,571 35,237 35,721 35,904

EBITDA (Rsmn) 7,112 7,362 7,612 7,793 7,862

PAT (Rsmn) 5,245 5,413 5,580 5,701 5,747

EPS (Rs/share) 10.60 10.93 11.27 11.52 11.61



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Exhibit 52: Gross margin sensitivity (Rs/ltr)

Impact in CY13 (Rs/ltr) 60 62 64 66 68

Revenue (Rsmn) 33,193 33,609 34,024 34,439 34,855

EBITDA (Rsmn) 5,539 5,940 6,341 6,742 7,143

PAT (Rsmn) 4,114 4,382 4,651 4,920 5,188

EPS (Rs/share) 8.31 8.85 9.40 9.94 10.48

Impact in CY14 64 66 68 70 72

Revenue (Rsmn) 34,431 34,861 35,291 35,721 36,150

EBITDA (Rsmn) 6,549 6,964 7,379 7,793 8,208

PAT (Rsmn) 4,868 5,146 5,424 5,701 5,979

EPS (Rs/share) 9.83 10.40 10.96 11.52 12.08



Exhibit 53: Target price sensitivity to exchange rate & gross margin (CY14)

Rs/ltr / Rs/US$ 48 50 52 55 57 59

64 321 320 319 318 318 317

65 326 325 324 324 323 322

66 331 330 330 329 328 327

67 336 335 335 334 333 333

68 341 341 340 339 338 338

69 346 346 345 344 344 343

70 351 351 350 349 349 348

71 357 356 355 354 354 353

72 362 361 361 360 359 358

73 367 366 366 365 364 364


Exhibit 54: Target price sensitivity to Brent crude & gross margin (CY14)

Rs/ltr / US$/bbl 95 100 105 110 115 120

64 319 318 318 317 317 317

65 324 324 323 323 322 322

66 329 329 328 328 327 327

67 334 334 333 333 332 332

68 339 339 339 338 338 337

69 345 344 344 343 343 342

70 350 349 349 348 348 347

71 355 354 354 354 353 353

72 360 360 359 359 358 358

73 365 365 364 364 363 363




Exhibit 55: Income statement


Net sales 27,348 29,818 31,968 34,439 35,721

% growth 18.0 9.0 7.2 7.7 3.7

Staff costs 1,029 1,078 1,153 1,211 1,272

Raw materials 13,847 16,945 19,073 20,405 20,354

Adv.& sales prom. exp. 2,372 2,154 2,423 2,321 2,401

Others 2,849 3,057 3,307 3,760 3,901

Total expenditure 20,097 23,234 26,204 27,928 28,166

EBITDA 7,251 6,584 6,013 6,742 7,793

% growth 26.0 (9.2) (8.7) 12.1 15.6

EBITDA margin (%) 26.5 22.1 18.8 19.6 21.8

Other income 395 846 752 851 975

Interest costs 24 19 20 20 20

Depreciation 243 251 249 231 239

Profit before tax 7,378 7,160 6,496 7,343 8,510

% growth 27 (3) (9) 13 16

Tax 2,475 2,349 2,136 2,423 2,808

Effective tax rate (%) 33.5 32.8 32.9 33.0 33.0

Net profit 4,903 4,811 4,359 4,920 5,701

% growth 28.7 (1.9) (9.4) 12.8 15.9

EPS (Rs) 9.9 9.7 8.8 9.9 11.5

DPS (Rs) 7.5 7.5 6.8 7.7 9.2

Payout (%) 75.7 77.1 77.0 77.0 80.0


Exhibit 57: Balance Sheet


Equity 2,473 2,473 2,473 2,473 2,473

Reserves 3,062 3,569 4,035 4,560 4,971

Net worth 5,535 6,042 6,508 7,033 7,444

Total loans 0 0 0 0 0

Liabilities 5,535 6,042 6,508 7,033 7,444

Gross block 2,955 3,066 3,186 3,296 3,411

Depreciation 1,752 1,941 2,004 2,235 2,473

Net block 1,203 1,125 1,182 1,061 938

CWIP 166 310 300 300 295

Deferred tax assets 371 562 562 562 562

Inventories 2,442 3,009 3,553 3,634 3,625

Debtors 1,784 2,190 2,628 2,831 2,936

Cash 6,193 5,490 5,646 6,881 8,414

Other current assets 51 85 85 85 85

Loans & advances 1,158 1,262 1,262 1,262 1,262

Total current assets 11,628 12,035 13,174 14,692 16,321

Creditors 4,949 5,140 4,817 5,190 5,383

Provisions 2,884 2,852 3,894 4,394 5,291

Total current liabilities 7,833 7,991 8,711 9,584 10,673

Net current assets 3,795 4,044 4,463 5,108 5,648

Total Assets 5,535 6,042 6,508 7,033 7,444


Financials

Exhibit 56: Cash flow


EBIT 7,403 7,179 6,516 7,363 8,530

(Inc.)/dec. in working capital 364 (952) (263) 589 994

Cash flow from operations 7,767 6,227 6,253 7,952 9,523

Other income (395) (846) (752) (851) (975)

Depreciation 243 251 249 231 239

Interest paid (-) (24) (19) (20) (20) (20)

Tax paid (-) (2,475) (2,349) (2,136) (2,423) (2,808)

Dividends paid (-) (4,325) (4,311) (3,894) (4,394) (5,291)

Net cash from operations 790 (1,047) (300) 494 668

Capital expenditure (-) (54) (256) (110) (110) (110)

Net cash after capex 736 (1,303) (410) 384 558

Inc./(dec.) in borrowings 0 0 0 0 0

(Inc.)/dec. in investments 5 0 0 0 0

Equity issue/(buyback) 1,236 0 0 0 0

Cash from financial activities 1,242 0 0 0 0

Others (1,043) 600 566 851 975

Opening cash 5,258 6,193 5,490 5,646 6,881

Closing cash 6,193 5,490 5,646 6,881 8,414

Change in cash 935 (703) 156 1,235 1,533


Exhibit 58: Key ratios

Y/E December CY10 CY11 CY12E CY13E CY14E

Per share

EPS 9.9 9.7 8.8 9.9 11.5

Book value per share 11 12 13 14 15

Dividend per share 7 7 7 8 9

Cash EPS per share 10.4 10.2 9.3 10.4 12.0

Free cash flow per share 11.1 7.8 8.6 11.4 13.8

Valuation (x)

P/E 30.1 30.6 33.8 30.0 25.9

P/BV 26.6 24.4 22.6 21.0 19.8

EV/EBITDA 19.5 21.5 23.6 20.8 17.8

Margins (%)

EBITDA margin 26.5 22.1 18.8 19.6 21.8

Net profit margin 17.9 16.1 13.6 14.3 16.0

Asset-based ratios (%)

RoAE 93.5 83.1 69.5 72.7 78.8

RoACE 93.8 83.3 69.7 72.9 79.0




Disclaimer Stock Ratings Absolute Returns

BUY > 15%

HOLD 0-15%

SELL < 0%

This report is published by Nirmal Bang’s Institutional Equities Research desk. Nirmal Bang has other business units with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information for the clients of Nirmal Bang Equities Pvt. Ltd., a division of Nirmal Bang, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. Nirmal Bang or any persons connected with it do not accept any liability arising from the use of this document or the information contained therein. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. Nirmal Bang or any of its connected persons including its directors or subsidiaries or associates or employees or agents shall not be in any way responsible for any loss or damage that may arise to any person/s from any inadvertent error in the information contained, views and opinions expressed in this publication.

Team Details:

Name Email Id Direct Line

Rahul Arora CEO [email protected] +91 22 3926 8098 / 99

Hemindra Hazari Head of Research [email protected] +91 22 3926 8017 / 18

Sales and Dealing:

Neha Grover AVP Sales [email protected] +91 22 3926 8093

Ravi Jagtiani Dealing Desk [email protected] +91 22 3926 8230, +91 22 6636 8832

Sudhindar Rao Dealing Desk [email protected] +91 22 3926 8229

Pradeep Kasat Dealing Desk [email protected] +91 22 3926 8102/8103, +91 22 6636 8831

Michael Pillai Dealing Desk [email protected] +91 22 3926 8100/8101, +91 22 6636 8830

Nirmal Bang Equities Pvt. Ltd.

Correspondence Address

B-2, 301/302, Marathon Innova,

Nr. Peninsula Corporate Park

Lower Parel (W), Mumbai-400013.

Board No. : 91 22 3926 8000/1

Fax. : 022 3926 8010

Documents

Institutional Equities - The Smart Investorsmartinvestor.business-standard.com/BSCMS/PDF/castrol india_31121… · Castrol India has so far ably defended its market share in the lube