Castrol India: Well-oiled for growth

Rebound in auto sales, lower crude oil prices to boost growth

Castrol India is a key beneficiary of falling crude oil prices, as a majority of its inputs are oil derivatives. This will rub off favourably on profitability, to be reflected from the March quarter. Analysts at ICICI Securities expect Castrol’s earnings before interest, tax, depreciation and amortisation to increase from Rs 34.9 per litre in the calender year (CY) 2013 to Rs 60.4 per litre in CY16, on account of stable realisations and decline in raw material costs.

While Castrol might also pass on some of the benefits to end users via price cuts on — lubricants limiting its margin gains, given the intensifying competition from oil marketing companies (OMCs), MNCs such as Shell, Exxon, etc, any move to cut lubricant prices could increase demand. Overall, analysts could raise their CY15 earnings per share (EPS) estimates by 10-13 per cent for the company, to factor in lower crude oil prices.

Benign input costs is one positive. Expected pick-up in commercial vehicle (CV) sales (CV lubricants form 30 per cent of its revenues) and likely gains on macro growth are other positives. Weak automobile sales had hit demand for  lubricants (about 90 per cent of Castrol’s revenues), resulting in a 3.5 per cent compounded annual fall in its total volumes over CY10-13. Now, Castrol’s volumes are likely to register compounded annual growth of two-three per cent over CY14-16, estimate analysts.

Its increasing focus on the high-margin personal mobility market (passenger vehicles, motorcycles) and high-margin semi-synthetic and synthetic lubricants will further drive profitability. Consequently, return ratios are likely to improve. Analysts at Motilal Oswal Securities expect Castrol’s return on equity ratio to improve 340 basis points to 73.8 per cent in CY15 over CY14 and return on capital employed to expand 830 basis points to 100.2 per cent in the period.

Not surprisingly, the scrip has outperformed the Sensex in the past year and continues to trade at rich valuations. At current levels, the stock trades at 35 times CY15 estimated earnings, higher than its three years' average one-year forward PE of 29 times. Long-term investors, thus, should wait for a correction before considering the stock.

Strong parentage (British Petroleum) enables Castrol to gain from exclusive tie-ups with original equipment manufacturers apart from capital and technological support, giving it an advantage over competition. Castrol products command average pricing premium of about 20% over competitors.

While competitive intensity is rising, the company has stepped up focus on high-margin products. Sustaining of this pricing power will depend on successful implementation of this strategy. Slower than anticipated recovery in the country's economy or a rebound in crude oil price though are key downside risks.