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Castrol India (CSTRL)
Energy
Up, up and away. We have been baffled by the recent spurt in Castrol’s stock price
post the announcement of cut in customs duty on LOBS. We retain our SELL rating on
the stock with a revised target price of `420 (`385 previously) given the stock is trading
at 25.7X CY2011E EPS. We do not agree with the view adopted by a section of the
Street that the stock should command a multiple in line with FMCG companies as we
see glaring difference in the earnings profile between the two. We have revised our
earnings to reflect (1) CY2010 annual report, (2) changes in customs duty on LOBS and
(3) revised exchange rate assumptions.
The recent run-up in stock prices is hard to justify
We are perplexed by the recent sharp run-up (+17%) in the stock since the announcement of
reduction in customs duty for base oils to 5.15% (10.3% previously) on June 24, 2011 given the
relatively moderate positive impact of `1.5 (+7%) to CY2012E EPS. The cut in customs duty results
in addition of Rs39 to the fair value even if we assuming the market-ascribed multiple of 25.7 X
(which itself seems stretched). However, the stock has already run up by `81 since the
announcement.
26X multiple for 6% earnings CAGR in CY2010-13E
We find the valuation of the stock expensive at 26X CY2011E EPS given relatively modest CAGR of
6% for earnings in CY2010-13E. The stock has historically traded in band of 14-18X (see Exhibit
1). We rule out higher growth in earnings as it will be challenging for the company to increase
market share and/or expand already high EBITDA margins (24-25%) in an increasingly competitive
market due to increased focus of OMCs (BPCL, HPCL and IOCL) and other players (Tide Water Oil,
Gulf Oil, Savita Oil, Helix, Petronas and Valvoline Cummins). We currently assume a net realization
of `69.3/liter for CY2011E, which is significantly higher versus `62.1/liter in CY2010, `61.1/liter in
CY2009 and `40.7/liter in CY2008.
Revision in earnings and target price
We have revised our EPS estimates for Castrol to `22.4, `23.2 and `23.7 in CY2011E, CY2012E
and CY2013E from `20.7, `21.3 and `21.8 to reflect (1) CY2010 annual report, (2) revised rupee
exchange rate assumptions, (3) recent reduction in customs duty for base oils to 5.15% (10.3%
previously) and (4) other minor changes. We maintain our SELL rating on the stock with a revised
target price of `420 (`385 previously) given (1) 26% downside from current levels and (2)
expensive valuations with stock trading at 24.8X CY2012E EPS of `23.2.
Closure of Tondiarpet plant due to higher operating costs
Castrol India has announced closure of its manufacturing facility at Tondiarpet from August
1, 2011 due to high manufacturing cost per liter resulting from high landed cost of LOBS on
the east coast. The company has decided to phase out the manufacturing activities at the
plant which is fully depreciated. However, the management has not decided on the course
of action to be taken for the disposal of land and assets.
Comparison to FMCG companies may not be judicious
We do not conform to the idea of ascribing a higher multiple to Castrol on the argument
that the business of the company is similar to the FMCG companies. In our opinion, the
multiple to be ascribed to a company is dependent on the earnings/cash flow growth
irrespective of the sector classification of the company. We analyze the various drivers for
Castrol’s earnings and draw a comparison with FMCG companies to substantiate our
investment thesis on the stock.
` Volume growth will be muted for Castrol given its nature of business. We highlight
that the sales volumes for Castrol for CY2010 are 2.3% lower than the sales volumes in
CY2004. The absence of volume growth for Castrol despite a sharp increase in automotive
sales reflects (1) increase in oil-drain intervals for commercial vehicles and (2) lower
lubricant consumption at the time of replacement given technology advancements.
In comparison, we note that FMCG companies have reported a robust volume growth
CAGR of 10-25% over FY2007-11. Exhibit 2 gives the volumes growth of the key
segments for some FMCG companies. In addition, we do not rule out downside risks to
our volumes assumption for Castrol in light of intense competition from PSUs and new
players in the industry. We assume volume growth of ~2% for CY2011-12E which
reflects higher consumption from (1) passenger cars and two-wheelers and (2) industrial
segment. However, the growth in these segments will be mitigated by reduction in
consumption from commercial vehicles given increase in oil-drain interval.
` Earnings growth driven by margin expansion may not be sustainable. We note that
the growth in earnings for Castrol in CY2006-09 has largely been driven by expansion in
margins/net realization (per liter). Castrol’s net realization has increased from `24.2/liter in
CY2006 to `62.1/liter in CY2010. We are already factoring a very strong net realization at
`69.3/liter in CY2011E and `70.5/liter in CY2012E. We see limited upside risks to our
assumption.
We expect a modest earnings growth for Castrol of 2-3% over CY2012-13E given (1)
modest volume growth and (2) modest increase in net realization. In contrast, FMCG
companies are expected to report a healthy ~22% growth in earnings in FY2012E. We
find it difficult to justify the use of a similar multiple for FMCG companies and Castrol
given the sharp contrast in their earnings profile. We highlight that the sharp yoy growth
in CY2011E EPS is on account of recent reduction in customs duty for base oils to 5.15%
(10.3% previously).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Castrol India (CSTRL)
Energy
Up, up and away. We have been baffled by the recent spurt in Castrol’s stock price
post the announcement of cut in customs duty on LOBS. We retain our SELL rating on
the stock with a revised target price of `420 (`385 previously) given the stock is trading
at 25.7X CY2011E EPS. We do not agree with the view adopted by a section of the
Street that the stock should command a multiple in line with FMCG companies as we
see glaring difference in the earnings profile between the two. We have revised our
earnings to reflect (1) CY2010 annual report, (2) changes in customs duty on LOBS and
(3) revised exchange rate assumptions.
The recent run-up in stock prices is hard to justify
We are perplexed by the recent sharp run-up (+17%) in the stock since the announcement of
reduction in customs duty for base oils to 5.15% (10.3% previously) on June 24, 2011 given the
relatively moderate positive impact of `1.5 (+7%) to CY2012E EPS. The cut in customs duty results
in addition of Rs39 to the fair value even if we assuming the market-ascribed multiple of 25.7 X
(which itself seems stretched). However, the stock has already run up by `81 since the
announcement.
26X multiple for 6% earnings CAGR in CY2010-13E
We find the valuation of the stock expensive at 26X CY2011E EPS given relatively modest CAGR of
6% for earnings in CY2010-13E. The stock has historically traded in band of 14-18X (see Exhibit
1). We rule out higher growth in earnings as it will be challenging for the company to increase
market share and/or expand already high EBITDA margins (24-25%) in an increasingly competitive
market due to increased focus of OMCs (BPCL, HPCL and IOCL) and other players (Tide Water Oil,
Gulf Oil, Savita Oil, Helix, Petronas and Valvoline Cummins). We currently assume a net realization
of `69.3/liter for CY2011E, which is significantly higher versus `62.1/liter in CY2010, `61.1/liter in
CY2009 and `40.7/liter in CY2008.
Revision in earnings and target price
We have revised our EPS estimates for Castrol to `22.4, `23.2 and `23.7 in CY2011E, CY2012E
and CY2013E from `20.7, `21.3 and `21.8 to reflect (1) CY2010 annual report, (2) revised rupee
exchange rate assumptions, (3) recent reduction in customs duty for base oils to 5.15% (10.3%
previously) and (4) other minor changes. We maintain our SELL rating on the stock with a revised
target price of `420 (`385 previously) given (1) 26% downside from current levels and (2)
expensive valuations with stock trading at 24.8X CY2012E EPS of `23.2.
Closure of Tondiarpet plant due to higher operating costs
Castrol India has announced closure of its manufacturing facility at Tondiarpet from August
1, 2011 due to high manufacturing cost per liter resulting from high landed cost of LOBS on
the east coast. The company has decided to phase out the manufacturing activities at the
plant which is fully depreciated. However, the management has not decided on the course
of action to be taken for the disposal of land and assets.
Comparison to FMCG companies may not be judicious
We do not conform to the idea of ascribing a higher multiple to Castrol on the argument
that the business of the company is similar to the FMCG companies. In our opinion, the
multiple to be ascribed to a company is dependent on the earnings/cash flow growth
irrespective of the sector classification of the company. We analyze the various drivers for
Castrol’s earnings and draw a comparison with FMCG companies to substantiate our
investment thesis on the stock.
` Volume growth will be muted for Castrol given its nature of business. We highlight
that the sales volumes for Castrol for CY2010 are 2.3% lower than the sales volumes in
CY2004. The absence of volume growth for Castrol despite a sharp increase in automotive
sales reflects (1) increase in oil-drain intervals for commercial vehicles and (2) lower
lubricant consumption at the time of replacement given technology advancements.
In comparison, we note that FMCG companies have reported a robust volume growth
CAGR of 10-25% over FY2007-11. Exhibit 2 gives the volumes growth of the key
segments for some FMCG companies. In addition, we do not rule out downside risks to
our volumes assumption for Castrol in light of intense competition from PSUs and new
players in the industry. We assume volume growth of ~2% for CY2011-12E which
reflects higher consumption from (1) passenger cars and two-wheelers and (2) industrial
segment. However, the growth in these segments will be mitigated by reduction in
consumption from commercial vehicles given increase in oil-drain interval.
` Earnings growth driven by margin expansion may not be sustainable. We note that
the growth in earnings for Castrol in CY2006-09 has largely been driven by expansion in
margins/net realization (per liter). Castrol’s net realization has increased from `24.2/liter in
CY2006 to `62.1/liter in CY2010. We are already factoring a very strong net realization at
`69.3/liter in CY2011E and `70.5/liter in CY2012E. We see limited upside risks to our
assumption.
We expect a modest earnings growth for Castrol of 2-3% over CY2012-13E given (1)
modest volume growth and (2) modest increase in net realization. In contrast, FMCG
companies are expected to report a healthy ~22% growth in earnings in FY2012E. We
find it difficult to justify the use of a similar multiple for FMCG companies and Castrol
given the sharp contrast in their earnings profile. We highlight that the sharp yoy growth
in CY2011E EPS is on account of recent reduction in customs duty for base oils to 5.15%
(10.3% previously).
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