Castrol India

A high dividend yield, stable business and sound financials make Castrol an attractive pick for long-term investors. It’s a must-have defensive bet during tough times

Beta: 0.41
Institutional Holding: 13.5%
Dividend Yield: 4.6%
P/E: 13.7
M-Cap: Rs 3,739.5 cr

AROBUST balance sheet, sound business model and strong brand equity of its products is enabling Castrol India to churn out good cash flows year after year. Even amidst a slump in the automobile sector, the company’s lubricants will still have a large potential market to tap.

In the past five years, there has been a dramatic increase in the number of cars and commercial vehicles on India’s roads. This aftermarket is likely to be a big growth driver for the lubricant industry in general and Castrol in particular, over the next few years. With a year-on-year outperformance of 10%, Castrol is a must-have defensive stock during difficult times.

BUSINESS:

Castrol India is the Indian subsidiary of UK-based Burma Castrol and is engaged in manufacturing and marketing of automotive and industrial lubricants and specialty products. It operates in the automotive as well as nonautomotive segments. The former includes oils for heavy-duty vehicles, cars, motorcycles and bikes, while the latter includes industrial lubricants, marine and energy lubricants and the services segment.

Public sector players like IndianOil, Bharat Petroleum (BPCL) and Castrol account for around 70% of the domestic lubricants market. Several other players, including global majors, account for the balance share, resulting in a highly competitive market. Besides having technologically superior products, Castrol also has strong distribution network and brand recall. The company is the market leader in the retail segment with a share of around 21% in the total automotive lubricants market.

GROWTH STRATEGY:

Castrol has gained market share in a declining lubricants market. The entry of new original equipment manufacturers (OEMs) offering new technology vehicles will provide additional opportunities for the company’s products. Lube consumption is projected to grow strongly in cars, fourstroke bikes, as well as building and construction equipment segments.

Gradual growth in personal mobility, as well as corresponding growth in demand for automotive services, are positive factors for the company in the long term. Castrol seeks revenue and value growth through higher dependence on superior technology products relevant to new generation of vehicles, as well as focus on volume growth in the key growth sectors which it has identified. Rather than a broad volume growth strategy, the company is looking at building on profitability.

FINANCIALS:

The company’s balance sheet size has only doubled in the past one-and-a-half decades, while its topline has quadrupled. This shows that the business is not capital-intensive and is earning high returns. The company’s return on capital employed (RoCE) for CY07 stood at 80%. Like a typical multinational company, Castrol adopts conservative financing by being debtfree and distributing the bulk of its profits in the form of dividends.

The company’s net sales have witnessed a compound annual growth rate (CAGR) of 10.8% over the fiveyear period ended December ’07 to Rs 1,966 crore. Its net profit has recorded a lower CAGR of 7.4% to Rs 218.4 crore. At an average payout of 85% of its profits, the company’s dividend payout has broadly grown in line with the corresponding growth in profit during the past five years.

Castrol posted a smart recovery in its operating and net profit margins in ’07. This was fuelled by certain factors like price hikes, exit from low-margin segments that have been commoditised, new product launches, and re-launch of old products with new identity, packaging and strong consumer propositions.

Rising crude oil prices have been a concern for the company since the past two years as oil is a critical raw material for lubricants. However, the company is expected to benefit from the recent crash in crude prices.

CONCERNS:

The growth in use of longer drain lubricants, especially in the commercial vehicle segment, is expected to significantly reduce consumption of lubricant per vehicle. This is expected to reduce volume growth significantly over the next 3-5 years.

Price undercutting by low-cost competitors in an attempt to gain volume share is another threat for this premium-category lubricant manufacturer. A long-drawn slump in the automobile segment may hamper future volume growth of the company’s products. Curtail in infrastructure spend due to the general economic slowdown is also likely to curb the market for lubricants. With an industrial slowdown, the company’s business in the non-automotive segment may also take a hit.

VALUATIONS:

Castrol’s current price-earnings (P/E) multiple is 13.7. This is fairly in line with the 12.8% growth in profit registered by the company over a period of 15 years. The stock is fairly valued at current multiples. Besides, a high dividend yield, stable business and sound financials make the stock an attractive pick for the long term.