Stock Review: Castrol India Ltd

Castrol India Ltd (CIL) is the second-largest player in the Indian lubrication industry. From just 6 per cent market share in 1993, the company now commands approximately 20 per cent of the lubrication market. It was the first to advertise and promote engine oils. CIL's innovative and attention-grabbing advertisements have over the years strengthened its brand image. Its business can be classified into three categories — automotive, industrial, and marine.

 

History

 

CIL commenced operation in India in 1919 as a trading unit of C C Wakefield. In 1983 it went public, with 60 per cent of its equity being held by retail investors. In 1994 Burmah Castrol increased its shareholding in the company to 51 per cent. Following the takeover of Burmah Castrol by BP in 2000, the latter took control of the company with 71 per cent shareholding. After the amalgamation of Tata BP Lubricants India Limited with CIL in May 2003, BP now holds 71.3 per cent stake in the company.

 

Industry dynamics

The Indian lubricant industry is around Rs 17,000 crore in size and is growing at approximately 5 per cent per annum. It is the fifth-largest lubricant market in the world. The top four players — Indian Oil Corporation Limited (IOCL), CIL, Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL) — control 70 per cent of the market. The rest is shared by both regional and global players. CIL commands approximately 20 per cent market share, which it has gained at the expense of the market leader, Servo of IOCL (which has 40 per cent share).

 

Sources of moat

Brand. The credit for transforming lubricants into a fast moving consumer good, where branding holds the key, goes to CIL. With its tagline, "It's more than just oil; it's liquid engineering", the company has been able to establish an unprompted brand awareness of 92 per cent (according to AC Nielsen Brand Tracker).

Despite as many as 27 brands vying for the same set of customers, CIL has been able to hold its own. Customers in this industry look at the value proposition (price to performance ratio) of different brands and then make an informed decision. Customer awareness of brands is high in this industry. In such a market, CIL has been able to demonstrate to its customers that its engine oil is more effective and also results in cost savings for them.

Around 2002, CIL found that sales of CRB Plus, its tractor engine oil (its flagship brand which in 2007 completed 75 years), were dropping. To re-establish its position, it offered live demos to people to visually demonstrate the heatproof technology of CRB Plus.

Moreover, CIL has strong tie-ups with original equipment manufacturers (OEMs) like Tata, Maruti Suzuki, Ford, BMW, Volvo, Volkswagen and Audi in the automobile segment; Mahindra & Mahindra and John Deere in the tractor segment; and JCB, L&T Komatsu, and Telcon among commercial equipment manufacturers. It was the first to bring out an engine oil for Maruti 800. This engine oil was endorsed by the company, Maruti Suzuki.

Product differentiation. A lubricant is not just a commodity but a blend of base oil and chemical additives. Its functions are to reduce friction among mechanical parts, protect them from wear and tear, keep them clean, control the heat generated, and reduce energy consumption and emissions. Hence a perfect blend is essential to enhance the performance of engines. Over the years, CIL has been able to demonstrate to its customers that using its products enhances engine life.

The company has a full-fledged R&D centre in Mumbai. With its in-depth understanding of the Indian market, it has been able to launch products that satisfy customer needs. It has about 100 automotive lubricants and 300 industrial lubricants in its arsenal. In addition, it has access to BP's 5,000 products.

Pricing power. After the decontrol of the industry in 1993, CIL concentrated on cost effectiveness rather than on volume growth. Its superior technology has enabled the company to maintain an edge over its competitors. Its 12-month trailing (till March 2011) operating margin stands at 17.10 per cent. Over the last five years CIL's margins have improved consistently. It has been able to leverage its brand to pass on increases in the prices of raw material to its customers. Moreover, its focus on the premium segment has also aided CIL in maintaining a healthy margin.

Distribution. In India petrol pumps are still the fiefdom of PSU oil marketing companies like IOCL, HPCL and BPCL which have their own lubricant brands. Hence, early on CIL understood that trying to push its products through petrol pumps wouldn't go a long way, Instead it adopted the "bazaar route", wherein it employed distributors who would directly cater to shops selling lubricants. It has around 270 distributors who service 70,000 plus outlets. Servo, on the other hand, has access to about 40,000 outlets.
In 2007, the company set up Castrol Authorised Service Associates (CASA) who service independent workshops. Till date with 400 CASAs CIL has been able to reach 12,000 workshops.

 

Could the moat be breached?

Competition. As we mentioned earlier, this is a very competitive industry, with strong domestic and international players. Domestically there is competition from IOCL's Servo (the market leader), BPCL's MAK, and HPCL's HP Lube. Among international players there is Royal Dutch Shell, the global market leader. Therefore, there is no shortage of contenders wanting to usurp CIL's position. However, till date nobody has been able to match CIL on strategy. In terms of brand recall or products so far no one has come close to CIL. In distribution only Servo comes close.

Undercutting. In spite of the cut-throat competition that prevails in the lubricant sector, no rival has resorted to undercutting so far. Even though the public sector oil marketing companies have the distribution muscle to undercut CIL, their existing losses from selling petrol and diesel have kept them from posing a serious threat to it. Moreover, as long as customers are prepared to pay a premium for quality, CIL will be able to retain its moat.

 

Financials

CIL has shown remarkable financial performance in the past five years. Between CY05-10, its sales grew from Rs 1,430 crore to Rs 2,735 crore at a compounded annual growth rate (CAGR) of 14 per cent. Its profits grew at a much faster rate of 27 per cent over the same period, which demonstrates the company's ability to manage its expenditures. Efficient capital management has enabled the company to post an impressive five-year average return on capital employed (RoCE) of 98.23 per cent. Over the past five years, the company has grown at a faster rate than the entire industry. If it continues to do so in future, CIL could well snatch the market leader's crown from Servo. Currently the diesel engine oil business contributes 80-85 per cent of sales. However, its share of overall sales has been declining over the years. As more new generation trucks get launched, which require less frequent refills, sales of diesel engine oil are expected to fall, while the share of premium engine oils is expected to rise.

 

 

 

Valuations

The stock has earned the reputation of being a good downside protector even in the most trying times. It fell just 4.55 per cent in 2008 compared to the 52 per cent fall of the Sensex.

Despite the high returns of recent years, the stock can still be called a value pick: it is still trading at a price-earnings to growth ratio (PEG) of 0.92 (in addition, it also offers investors an attractive dividend yield of 3 per cent.) But compared to its five-year median price to earnings ratio of 18.59, it is trading at 25.10, a premium of 35 per cent. In order to enhance your margin of safety, buy this stock on dips and hold it for at least three years.