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Tuesday, August 5, 2008

Castrol India Ltd. (CIL)-Investment report

Report Date:August 2, 2008
Company Name: Castrol India Ltd. (CIL)
Recommendation: BUY
CMP – Rs. 289.1
Target Price – Rs. 350/-
Mkt. Cap. - Rs. 3,574.4 crore

Investment Rationale
Ø CIL, 71% subsidiary of Castrol UK (part of BP group) and largest private sector lubricant company, reported impressive performance in Q2 CY 2008, underpinned with shift profitable volume growth. Net sales rose by 15.1% to Rs. 621.4 crore on back of higher volumes & improved price realization to recover sharply escalating cost of goods. OPM% enhanced to 20.4% with reduction in material cost to 55.9% (58.5%) of sales owing to better procurement. Further aided by 16.5% higher other income of Rs. 9.2 crore (as had surplus cash of Rs. > Rs. 335 crore on Dec. 31, 2007) and 66.7% drop in interest of Rs. 70 lakh, PBT soared up by 26.4% to Rs. 128.2 crore and PAT by 25.6% to Rs. 82.8 crore

Ø For H1 CY 2008, sales grew @ 13.4% to Rs. 1114.3 crore. OPM% shot up to 21.5% (16.8%). Consequently, PBT spurted up by 47.3% to Rs. 246.1 crore and PAT by 45% to Rs. 155.7 crore.

Ø Automotive lubricant market is estimated to grow @ ~ 2-3% in volume terms. Over 1 million cars & utility Vehicles and ~ 6 million 4-Stroke 2-wheelers are projected to be sold in CY 2008. Building and Construction segment feeding infrastructure sector is expected to grow at faster pace during 2008 on back of similar growth in 2007. Thus, lube consumption is projected to grow strongly in cars, 4-stroke bikes and Building & Construction equipment segments.

Ø In automotive lubricant segment, company is focusing on hi-tech segments which offer profitable volume growth and move away from unprofitable volumes. As markets develop and auto industry advances technologically, focus shifts from overall volume to targeted volumes and hi-tech lubricants. This strategy helped company in minimize impact of raw material volatility and to deliver sustained growth in revenue & profit.

Ø Several global auto OEMs are entering Indian market with new technology, which will increase demand for high end lubricants. CIL, with record of strategic tie-ups with OEMs (signed up with Volvo, Audi and Ford during CY 2007), strong parentage and aggressive branding is all set to exploit increasing demand for automotive lubricant. In addition, key off-road equipment manufacturers have also chosen to extend their association with CIL, presenting strong business opportunities in future.

Ø With accelerating industrial growth, demand for industrial lubricants in segments like automotive, auto components, cement, textile machinery etc is on an upswing. Here technology involved in manufacturing is high and thus, CIL is able to sell high-tech and high margin lubricants.

Ø CIL is moving up the value chain through service formats like Castrol BikeZone, chain of multi-bike servicing outlets. CIL charges royalty for franchise. This business is expected to account for 10% of PAT in next 3-4 years.


Valuation
Ø Overall economic turmoil due to high inflation, interest rates, fuel prices, reduced economic activity, etc, will take its toll on overall lube volume consumption, at least in the short to medium term, primarily in the B2B customer base. Recognizing tough market conditions, CIL will focus on creating superior value for its customers by upgrading both its product and service offers. The company will also endeavour to grow in its profitable volume segments, focusing even more on value growth through superior, high technology products. However, if base oil and other input costs escalate rapidly, margins might be impacted in short term due to lag in recovery.

Ø CIL has record of good bonuses and high dividend payout. In CY 2007, it recommended dividend of 140% and has also declared interim dividend of 60% for CY 2008. At CMP, dividend yield works out to be ~ 4.8%. Going ahead too, CIL will have good dividend payout as company keeps on generating cash surplus and does not have large capex plan (since this business is not capital intensive).

Ø At CMP, share is trading at 11.8 times CY 2008 expected EPS of Rs. 24.50 and 9.3 times CY 2009 expected EPS of Rs. 31/-. In view of promising future outlook, we recommend to “BUY” the share at CMP.

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