Castrol India: A perfect blend

Despite short-term blips, Castrol India has the necessary ingredients to sustain healthy growth rates, and in a profitable manner.

Auto sales may have fallen in recent months, but with a large chunk of its sales coming from the replacement market and a substantial decline in raw material prices, Castrol India has a fairly decent cushion. Its focus on value-addition rather than volume growth and developing additional revenue streams are positive and will contribute in the long run. The technological support of its parent and strong brands will help Castrol maintain its stronghold in lubricants going ahead, as new vehicles that demand technologically advanced solutions are launched in the Indian market.

That’s because, the lubricant (like engine oil) is not just a commodity but, it is a blend of base oil and chemical additives. Its role is important and its primary functions are to reduce friction among mechanical parts, protect the parts from wear-and-tear and keep it clean, control the heat generated and reduce energy consumption and emissions. Thus, a perfect blend is essential to enhance performance levels.

Castrol India, a 71.03 per cent subsidiary of UK-based BP Group, sells lubricants under two brands namely, Castrol and BP and has a 100-year history in the country. Almost 80 per cent of its sales volume come from the auto space with the balance from industrial and marine segments. Notably, less than 10 per cent of lubricant sales to the auto segment are OEMs first-fills, with the balance accruing from channels like retail trade (market share of about 22 per cent, in value terms), OEM authorised workshops, independent workshops and B2B customers.

Short-term blip
While lower contribution from OEMs suggests that the recent decline in auto sales should not have a significant impact on volumes, there are two other events that point to slower volume growth in the near-term, largely due to tight liquidity conditions and lower economic output. Firstly, de-stocking by the trade is likely to impact primary sales (company to dealer) in the December quarter (Q4 CY08), and secondly, lower economic output means lesser movement of goods, which in turn, may also marginally impact volumes. For the latter, since bulk of the sales volume to the auto sector comes from the commercial vehicle segment, the impact will be felt in Q4, 08 and may extend to H1, CY09.

Changing dynamics and mix
Notably, even during boom times when vehicle sales were on the rise, lubricant volumes for Castrol India have grown at an average 1.13 per cent in the last five years. Among reasons for the same, is the shift in demand towards technologically advanced lubricants and increase in drain intervals (duration between changes in lubricants in vehicles has theoretically doubled). The use of technologically superior lubricants has however, led to a better rise in absolute sales and in realisation per unit. Castrol’s sales growth has averaged 10.7 per cent in the last five years (CY03-07).

Going ahead, the company sees relatively higher growth in categories like workshops and B2B sectors (fleet owners, building and construction sectors). In 2007, the company initiated the setting up of Castrol Authorised Service Associates (CASA). As on date, it has 400 CASAs, which service independent workshops (smaller mechanics) totaling over 12,000. In the B2B front, there is again a separate network to service the customers. On the other hand, Castrol also seeks to gain market share in the car and bike segments. With a strong nation-wide network of 270 distributors, which service over 70,000 outlets, achieving its goals should not be difficult for Castrol.

SMOOTH RIDE
	CY2007	CY2008 #	% Chg	CY2009 E
Net sales	1,966.0	1,670.0	18.2	2,460.0
OPM (%)	16.8	19.7	-	20.0
Net profit	218.5	215.2	33.1	318.0
EPS (Rs)	15.1	17.4	33.1	25.7
PE (x)	-	14.3 *		12.9
# For nine-mths ended Sept 2008; % Chg is y-o-y * annualised based on 9-mth results E: Estimates

Since these categories (personal mobility and B2B customers) are expected to grow at a faster clip in the next five years, expect Castrol’s overall revenue mix to improve gradually. Also, with plans to enhance the mix towards advanced technology products across customer categories, Castrol’s profitability should get a boost.

On a strong footing
While its parent is not new to global competition, its support to Castrol India, including providing access to technology, is vital for the latter’s long-term growth. Castrol India, too, has a full-fledged R&D centre in Mumbai, which along with its deep understanding of Indian consumers, gives it an edge over competitors, enabling it to launch products that meet customer needs. While the company already has a wide product range, on an average, it has been launching 3-5 new products (variants, SKUs) every year.

Little wonder that Castrol also has in place a range of products for use in CNG and LPG-based vehicles. Here, even as the market size for these products is small, it is growing rapidly due to the strong demand for such fuel vehicles. Its strengths in the business are also visible from tie-ups with global auto majors like BMW, VW, Ford, Audi and Volvo, that have entered the Indian market in recent years.

New revenue streams
In a bid that will deepen Castrol’s roots with retail customers and in an attempt to explore opportunities in adjacent areas, the company’s launched the ‘BikeZone’, a multi-brand two-wheeler service centre initiative built on modern retail format. The company has worked on developing a sustainable business model for itself as well as its franchisees. In 2009, one may see a rapid scale-up in this business. An indication of the business’ long-term prospects is that it has the potential to contribute up to 10 per cent of Castrol’s profit before tax (PBT) by 2012. At a mere growth of 10 per cent annually in PBT, this business could contribute over Rs 50 crore to PBT by 2012.

Investment rationale
Strong brands, extensive reach, deep customer knowledge, support of parent, wide product range and robust financials are key strengths of Castrol India. Focus on growth segments and foray into adjacent areas will help improve the business mix in the long run. All these together will help Castrol stay ahead of the industry.

In the near-term, while the slowing economic growth and tight liquidity conditions may impact volume growth, various initiatives including upgrading customers to value-added products should provide cushion. The falling input prices (base oil) should lead to improvement in margins, which have been under pressure despite the four price hikes undertaken in the last one year.

On an average, base oil prices (which increased by an average 30 per cent y-o-y in CY08) have slipped from $1,550 per metric tonne (MT) in August 2008 (peak levels) to $1,100 per MT in December, following the decline in crude oil prices. If crude oil price stabilises around $50-60 a barrel, expect base oil prices to slip to under $700 per MT in the next 2-3 months. While Castrol India will gain from this, a part of it will get offset on account of the weak India rupee vis-a-vis the US dollar. Nevertheless, the trend is positive and margins should improve from Q1 CY09 onwards. At Rs 331.70, the stock can deliver over 20 per cent returns in the next one year.