CASTROL INDIA: Superior Tech and Strong Brand Drive a Well-Oiled Show

The fall in crude oil prices and the subsequent decline in base oil prices will boost Castrol's margins. A rise in the rupee will also help. The improvement in profitability is expected to boost the company’s share price

    Castrol India is a natural beneficiary of the recent fall in crude oil prices. The company's raw material — base oil — is priced on crude oil, but its lubricants are branded and sold at MRP. As a result, the fall in crude oil prices and the subsequent fall in base oil prices will improve the company's margins. Any future appreciation in the rupee will make the proposition even more attractive. 

BUSINESS Castrol India is a subsidiary of British Petroleum operating in India's lubricants industry with a 20-22% market share in automotive lubricants. The company has invested heavily in its brand Castrol, which commands a premium in the industry. In spite of being a non-integrated lubricant maker, the company has maintained its market share even after price hikes thanks to superior technology, product differentiation, wider reach and a strong brand. Auto lubricants make up nearly 85% of the company's revenues while industrial products account for the rest.
The company has a wide network of around 270 distributors and around 70,000 retail outlets. This is supplemented with Castrol's own customer outreach initiatives such as Pit Stops, Safe2GO, Bike Zones and Sanjeevani. The company's major competitors include the state-run oil marketing companies IndianOil, BPCL and HPCL, apart from domestic players like Tide Water Oil, Gulf Oil and MNCs such as Shell, Mobil, Idemitsu and Total. 

GROWTH DRIVERS The fall in crude oil prices in the June 2012 quarter is likely to bring down Castrol's raw material costs helping improve margins and profitability in the coming quarters. Raw materials form the major portion of Castrol's costs, which rose from 48.5% of net sales in 2009 to 56.8% in 2011 and stood at 58.7% of net sales in the March 2012 quarter.
Other things remaining same, one percentage point drop in raw material cost in relation to net sales improves Castrol's pretax profits by over 4%.
However, there is always a lag effect between the price of crude oil and that of base oil. Due to this, the full benefit of a fall in raw material prices is likely to be seen in the July-September quarter. 

FINANCIALS Castrol's operating profit margins that remained around 24-25% levels in 2009 and 2010 weakened in the second half of 2011 to around 20%. The March quarter margins stood at 20.3%. Castrol is a debt-free company with nearly 550 crore of cash on its books at the end December 2011. It has a consistent dividend- paying record with a current yield of 2.8%. The company's return on capital employed (RoCE) has been above 100% for the last three years. 

VALUATIONS The company is currently valued at 28.3 times its earnings for the last 12 months and 21.8 times its book value. This may appear expensive when compared to other lubricant makers in India. However, Castrol's superior margins and return ratios are all due to its strong brand in the consumer segment. Other companies with similarly strong consumer brands such as Asian Paints, Jubilant Foodworks, TTK Prestige, Titan Industries and Page Industries enjoy even higher valuation multiples. An improvement in profitability, therefore, should boost Castrol's share price.