We explore the business of India’s leading player in the automotive and industrial lubricant market and assess the opportunities and challenges it faces.
Statutory Warning: This is NOT an investment advice to buy or sell shares. Please make your own decision, as blindly acting on anyone else’s research and opinions can be injurious to your wealth. I do not own the stock, but my analysis can be biased, and wrong. I have been wrong many times in the past. I, Vishal Khandelwal, am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014 (Registration No. INH000000578).
About Castrol India Ltd. (CIL)
CIL, part of Castrol Limited UK (part of BP Group), is India’s leading player in the automotive and industrial lubricant industry (lubricants reduce friction between metal surfaces, leading to reduction of heat generation and ultimately, to protection of the parts). It has more than 100-years old presence in India and currently has a share (in value terms) of around 20% in the domestic lubricants market. It operates through 3 manufacturing plants and a distribution network that services around 105,000 retail outlets across the country.
CIL operates in all major categories of the highly competitive lubricants industry, such as automotive, industrial and marine and energy applications. The industry is made up of over 30 established players. The company is the market leader and, along with national oil companies like IOC, HPCL and BPCL, accounts for around 40% of the market. Other multi-national companies (like Gulf Oil, Tide Water Oil) make up 30% of the market while local players constitute the rest. Over the years, CIL has established a well-entrenched position in automotive lubricants, the predominant category in this industry.
India, by the way, is the world’s third largest lubricants market, next only to US and China, with a total consumption of approximately 2.6 billion litres in 2016 (as per the company). Demand for automotive lubricants is driven by the usage of vehicles in the country, while the
growth in the market in recent years has been due to the rapid expansion of vehicle population. Demand for industrial lubricants has been observed to have a strong correlation with the Index of Industrial Production (IIP), which is largely driven by economic activity.
Let’s now analyze CIL using a set of questions to test the underlying business and management quality.
1. Has the company done well in terms of sales and profit growth over the past few years?
CIL has seen a muted 6% CAGR in sales over the past ten years, while PBT has grown at a CAGR of 11%. Now, while growth in sales has slowed down to a CAGR of 2% over the past 3 years, PBT growth improved to a CAGR 14% during the same period.
The revenue growth over the past few years has been impacted by declining volume growth – from 219 million litre in 2010 to 191 million litre in 2015 (latest available data).
Declining volumes were, however, countered by improved pricing, with the same rising from Rs 143 per litre in 2010 to Rs 198 in 2015.
Anyways, advancement of engine oil technology leading to longer oil drain intervals – time gap between oil change in a vehicle – has been one of the causes of CIL’s volume degrowth over the past few years. Another reason is CIL’s deliberate attempt to vacate the price-sensitive volume-driven market and focus aggressively on its premium brands. And this strategy seems to be working. As per the latest annual report (2017), the management has mentioned about 2017 being the second straight year of rising volume sales, which was driven by double-digit growth in personal mobility and premium brands. So, the situation on the revenue growth front seems to be improving for CIL, which is a good sign.
The management has also indicated its plans to achieve higher volume and revenue growth going forward by increasing its distribution footprint in the rural markets, focusing on greater premiumization in the personal mobility space, especially the passenger car oil segment. As per the management, the high-priced personal mobility oils, which are priced around two-times that of commercial vehicles oils, contribute 40% of CIL’s overall volumes now, as compared to 20% about five years ago and around 10% ten years ago. CIL is also increasing penetration in auto workshops through the launch of engagement programs with dealers and mechanics and investments in workshops, which is a good step towards increasing its reach and growth further.
Anyways, on the profits front, CIL has benefited from lower raw material prices thanks to decline in crude oil prices over the years (which have increased in recent times). Material costs have come down from 59% of sales in 2012 to 47% in 2017. Consequently, gross margin has improved from around 45% five years back to 55% now. Net profit margin has remained around 20% over the past three years, up from around 15% prior to that.
2. How profitably have retained earnings been reinvested?
CIL’s average ROCE over the past five years has been around 73% (10-year average of 71%). The company operates on an asset light model – fixed assets form just around 7% of the total asset base – and has no debt on the balance sheet. And thus, the high return on capital number.
3. Does the business have a durable competitive advantage?
CIL’s moat is its brand, which it has built over decades, despite intense competition from domestic and other MNC players. The company spends around 7-8% of its sales in brand building, which has paid dividends over years. The company enjoys tremendous pricing power, with most of its products commanding 20-25% premium over other similar products in the market.
Entry barriers in the lubricant industry are also high as it involves huge capital to enter this market. The new euro norms on car engines have made technology as an entry barrier and the existing players in the industry who do not have the capacity to invest in R&D for developing new oils for the new engines will surely be affected.
Another source of moat for CIL is its asset light business model (as mentioned above), that causes high return on capital. The company works on a negative working capital. Trade payables and other current financial liabilities stood at around Rs 840 crore in 2017. Compared to this, receivables plus inventories stood at Rs 600 crore.
In fact, even CIL’s net fixed assets at Rs 136 crore, when totaled with receivables and inventories, fall short of trade payables and other current financial liabilities. In simple words, the company’s creditors fund its working capital and fixed capital, which isn’t true of many other listed companies in India.
4. What are the risks to the business?
CIL’s business faces several risks, the primary being slow volume and revenue growth – both on the automotive and industrial fronts – as has been seen in the past. Any sharp increase in material prices (crude oil) is another risk that the company faces, this time on the margin front. Intensive competition, which has not been able to dent much in the past, remains a risk to the company’s growth and profitability.
CIL’s stock is currently trading at a market cap of around Rs 17,300 crore, which implies a P/E multiple of 25x its 2017 net profit of Rs 692 crore.
While revenue growth has been a concern for CIL in the past, the same seems to be on a revival, which is a positive sign. The company has also seen improvement/stability across its profitability metrics, led by increased premiumization of products leading to better pricing. Given the rapid pace of industrialization and good growth in automobile sales, growth is expected to improve going forward. The company also benefits from a clean and light balance sheet. You must, however, carefully assess the opportunities and risk in the business and ensure sufficient margin of safety before taking an investment decision.
Statutory Warning: This is NOT an investment advice to buy or sell shares. Please make your own decision, as blindly acting on anyone else’s research and opinions can be injurious to your wealth. I do not own the stock, but my analysis can be biased, and wrong. I have been wrong many times in the past. I, Vishal Khandelwal, am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014 (Registration No. INH000000578).[/show_to] [hide_from accesslevel=’almanack’]
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