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Castrol India (CSTRL)
Energy
Tougher times ahead. We maintain our cautious view on Castrol stock despite the
recent underperformance as we see potential contraction of margins led by (1) rising
LOBS prices and (2) weakening rupee. We also see risk from lower lubes consumption
from a potential hike in diesel price. We retain SELL rating on the stock given that the
stock is trading at 18% above our 12-month target price of `390.
Pressure on margins from higher LOBS prices
We note that LOBS prices have increased in the last one month led by (1) increase in crude oil
prices and (2) tight supplies (see Exhibit 1). We note that there is typically a lag in the movement in
LOBS prices versus crude oil prices and we expect LOBS prices to rise further from current levels.
We see downside risk to margins and earnings due to increase in LOBS prices unless the company
is able to pass on the increase through hike in price of lubes. Castrol’s earnings are highly
leveraged to raw material costs; a US$25/ton increase in raw material costs will impact Castrol’s
EPS by 3%.
Weakening rupee does not auger well for earnings
A depreciation in the value of rupee versus the US dollar would be negative for earnings as it will
increase the cost of raw materials (LOBS and additives), which constitute a significant portion of
Castrol’s overall costs. A `1/US$ increase would reduce Castrol’s CY2011E and CY2012E EPS to
`21.2 (-2.6%) and `22 (-2.5%).
Growth in volumes will be muted
We highlight that volume growth will be muted in the future quarters as the impact of low base in
1HCY09 has fazed out. We highlight that Castrol reported a yoy decline in volumes in 3QCY10
versus 20.8% in 1QCY10 and 7.5% in 2QCY10 (see Exhibit 2). We assume a healthy growth of
6% in 4QCY10E. We also see potential decline in lube consumption from the possibility of
government’s decision to raise diesel prices over the next few months. This may hurt the
economics of freight operators who may delay consumption of replacement products such as
lubes and tyres.
Stock trading at 21.3X CY2011E EPS despite modest earnings growth
We believe the market is ascribing a high 21.3X multiple to Castrol’s CY2011E earnings despite a
low earnings CAGR of 3.7% in CY2010-12E. Castrol stock has historically traded in a P/E band of
14-18X (see Exhibit 3). We would be cautious in ascribing a higher multiple in light of modest
earnings growth in CY2011E and beyond. The stock is trading 18% above our 12-month target
price of `390 based on 18X 12-month forward EPS.
` Volumes. We currently model 8.6% yoy increase in sales volumes in CY2010E and 6%
yoy increase in sales volumes in 4QCY10E. We note that Castrol reported a yoy decline in
volumes in 3QCY10 versus 20.8% in 1QCY10 and 7.5% in 2QCY10. We model a 2%
yoy increase in sales volumes in CY2011E and CY2012E.
` Lubes prices. We model lube realization to increase by 11.1% in CY2010E to reflect the
price hikes taken by Castrol in January 2010 and July 2010. We model a 2% increase in
realization in CY2011E and CY2012E.
` LOBS prices. We model CY2010E LOBS prices at US$940/ton (+US$219/ton yoy) to
reflect higher crude prices yoy. We model yoy increase of US$10/ton in LOBS prices in
CY2011E and CY2012E.
` Exchange rate assumption. We model exchange rate for CY2010E and CY2011E at
Rs45.7/US$ and Rs44.5/US$.
` EBITDA margins. We currently assume an EBITDA margin of 27.8% for CY2011E, which
is higher than Castrol’s EBITDA margin of 24.8% in CY2009 and an average EBITDA
margin of 16.4% over CY2001-08
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