Stock Fundamentals

Why Castrol India is a good stock to invest in now

Anand Kalyanaraman | Updated on November 01, 2020 Published on October 31, 2020

The healthy pick-up seen in the recent September quarter should continue

Many businesses have been gradually getting back on the recovery path with the unlocking of the economy. Among these is lubricant-maker Castrol India, a leader in the segment.

After crashing in the June 2020 quarter due to the Covid-related lockdowns, the company’s volumes picked good pace in the recent September quarter — growing more than 60 per cent on a sequential quarter basis and about 6 per cent y-o-y (year-on-year).

Revenue in the September 2020 quarter at ₹883 crore was up about 80 per cent on a sequential basis and 4 per cent y-o-y. Profit at ₹205 crore more than tripled sequentially and was up about 9 per cent y-o-y.

Profit before tax was up 17 per cent y-o-y.

The good show, the company says, was aided by a partial revival of pent-up demand, a strong distribution network, well-known brands, and judicious working capital management. Demand from the agricultural sector and volume recovery in commercial vehicles and two-wheelers helped.

The market cheered the good performance, with the Castrol India stock rallying about 4 per cent last week.

At ₹114, the stock is now up about 15 per cent from its March lows. But it is still about 28 per cent down from its February high of ₹158. Investors with a long-term perspective can consider buying the stock.

What’s the drill

One, the valuation seems attractive with the trailing 12-month price-to-earnings ratio at 17 times, lower than its three-year average of 21 times and the 20 times of peer Gulf Oil Lubricants.

Two, the company is a regular dividend payer and the current dividend yield (based on calendar year 2019 dividend of ₹5.5 a share) is about 5 per cent.

Recently, the company declared an interim dividend of ₹2.5 a share for calendar year 2020, the record date of which is November 6, 2020. On the business front, volume and financial growth is expected to come back with economic recovery and some growth drivers.

In calendar 2019, before the pandemic-induced troubles struck, Castrol’s volumes had fallen about 4 per cent y-o-y and revenue was flat at ₹3,877 crore.

Profit, though, had risen about 17 per cent y-o-y to ₹825 crore, but much of this growth was due to lower tax that year. Operating profit had risen about 5 per cent y-o-y. In calendar 2018 and 2017, too, financial performance was weak, with profit growth in low single digits.

These had contributed to the stock’s subdued show for quite some time. The recovery in the recent September quarter should continue in the December quarter, aided by economic pick-up and pent-up demand in segments such as personal mobility.

Still, the performance in calendar 2020 is expected to dip due to the pandemic impact that was seen in the March and June quarters. But in calendar 2021, volume, sales and profit growth should accelerate.

 

Fuelled up

For one, the low base effect will help. Next, Castrol should benefit from the tie-up of BP (its promoter) and Reliance Industries.

This should help Castrol sell automotive lubricants exclusively to fuel pumps being set up by BP-Reliance Industries (from about 1,400 pumps, it is expected to go up to 5,500 in the next four-five years).

Also, auto sales picking up should benefit Castrol, given that automotive lubricants account for about 90 per cent of its volumes; non-automotive, including industrial, lubricants make up the rest. The company has products for BSVI vehicles and has agreements with vehicle manufacturers to supply them.

It has also planned new launches in the personal mobility segment that accounts for a chunk of the volumes.

Besides, replacement demand should keep demand ticking.

With economic pick-up, the demand for industrial lubricants should also eventually rise.

The company continues to expand its distribution network, including in rural areas, and invest in digital, brand building and advertising initiatives to drive growth.

If and when electric vehicles (EVs) become widespread in the country, it has agreements to supply EV fluids to vehicle-makers such as MG Motors and Tata Motors.

It helps that the cost of base oil (the key raw material) is expected to stay benign due to subdued crude oil prices; this, along with good pricing power, should aid the company’s margins. In the recent September quarter, operating margin improved to about 34 per cent from about 30 per cent in the year-ago period.

Margins should stay healthy even if not at current high levels.

Castrol has three manufacturing plants, and its current capacity utilisation is around 80 per cent. The company has a strong balance-sheet with zero debt and healthy cash reserves that give it the muscle to fund expansion.

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Published on October 31, 2020
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