Castrol India, a 71% subsidiary of British Petroleum Group (BP), is a leading lubricants player in I

30 July 2012

Initiating Coverage | Sector: Consumer

Castrol India

BSE SENSEX

S&P CNX

16,839

5,100

CMP: INR536

TP: INR629

Buy

Enduring and widening moat

A cash machine for shareholders; Buy for 17% upside

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1,6,12 Rel.Per. (%)

M.Cap (INR b)

M.Cap (USD b)

CSTRL IN

247.3

576/380

5/16/7

132.5

2.4



Valuation summary (INR m)

Y/E Dec

2012E 2013E 2014E

Net Sales

32.9 35.4 38.6

EBITDA

6.4

8.0

8.9

Adj NP

4.6

5.6

6.3

EPS (INR)

18.4 22.7 25.4

EPS Gr.(%)

-5

BV/Sh.(INR) 25.4 27.7 29.8

P/E(X)

29.1 23.6 21.1

P/BV (x)

21.1 19.4 18.0

EV/EBITDA (x) 19.8 15.8 14.0

EV/ Sales (x)

3.9

3.6

3.2

RoE (%)

83.8 74.0 85.6

RoCE (%)

109.4 99.1 116.7

Price as on 27 July 2012



Castrol India, a 71% subsidiary of British Petroleum Group (BP), is a leading lubricants

player in India, with ~19% market share in the auto lube bazzar segment.

Castrol provides a vehicle to invest in a company with multiple and rare moats, huge

free cash flows, high governance standards and reasonable valuations.

Its key focus area is the premium personal mobility automobile segment, which is

relatively insulated from economic cycles, unlike the freight and OE market.

Over CY01-11, Castrol has posted revenue and net profit CAGR of 10% and 16%

respectively, while it has generated shareholder returns of 22% (adjusted for dividends).

Given its predictable and stable FCFs, low re-investment requirements and consistent

payout ratio, we believe DCF is the best way to value the company.

We initiate coverage with a Buy rating and a target price of INR629, 17% upside.

Has created an enduring and widening moat

Despite intense competition in the lubricants industry in the last decade, Castrol

has been able to successfully create and appropriate value through adept market

segmentation. Its primary market is the premium personal mobility automobile

segment, where it is able to leverage its trusted brand, product performance

track record and unique service attributes. Unlike its competitors that have been

making low to negligible investments in their brands, Castrol has consistently

been investing 6-7% of its sales (INR2.2b in CY11) in brand-building. It enjoys

tremendous pricing power, with most of its products commanding 20-25%

premium.

Shareholding pattern (%)

As on

Jun-12 Mar-12 Jun-11

Promoter

71.0

Dom.Inst

7.1

7.0

6.9

Foreign

7.9

7.8

7.4

Others

13.9

14.1

14.7

To benefit from industry transition

During the last decade, the distribution channel for automotive lubricants (lubes)

witnessed a major transition from the traditional ‘public sector petrol pumps’ to

‘bazzar trade’, which was positive for private sector players such as Castrol, Shell

and Gulf Oil. The distribution channel is now undergoing another transition.

With engine technology advancing and maintenance becoming more

sophisticated, the workshop channel is gaining traction at the cost of other

distribution formats. This is likely to lead to further polarization in the industry

and benefit large lube marketers like Castrol that have strong/established

relationships with original equipment manufacturers (OEMs).

Stock performance (1 year)

Margin/unit to sustain, though volume growth to be muted

Over CY01-11, Castrol’s sales volumes have de-grown, not only due to increasing

drain interval, but also because it has deliberately vacated the price-sensitive

volume-driven market. Castrol depends on technology innovation and path-

breaking new product launches to drive growth and ability to organically generate

growth through internal initiatives is the most sustainable source of growth. We

model Castrol's net sales growth over CY12-21 at 9%. Concerns on account of

increasing drain intervals are largely unfounded, as Castrol has historically

Investors are advised to refer

through disclosures made at the end

of the Research Report.

30 July 2012

Castrol India

maintained its margin/unit, which we believe it can sustain. We estimate 2.4%

CAGR in Castrol’s volumes over CY12-14. However, revenue would grow at a CAGR

of 9%, driven by 6% CAGR in realizations. We expect EBIT margin to expand from

19.5% in CY11 to 22.2% in CY14 and estimate net profit CAGR at 17% over CY12-14.

A cash machine for shareholders; Buy

Over CY02-11, Castrol generated FCF of INR27b, with total reinvestment of negative

INR3b. Castrol’s cumulative net capex (capex - depreciation) over the period was a

negative INR408m, while cumulative net working capital (net of cash) was a negative

INR2.5b. It has paid out 87% of its FCF as dividend. Given its predictable and stable

FCFs, low re-investment requirements and consistent payout ratio, we believe DCF

is the best way to value the company.

We initiate coverage with a Buy rating and a

DCF-based target price of INR629, 17% upside.

Industry structure: A differentiated oligopoly market

Differentiated Oligopoly market

Top four players IOC/ HPCL/ BPCL and Castrol

control >80% of the market

Nature of Demand

1. Endogenous demand -

marketing matters

2. Earnings can be

managed by shifting

priorities appropriately

Nature of Firm Interaction

1. High interdependence amongst players

2. Maintaining distance amongst competitors

critical - segmentation matters

3. Oligopolies can retain abnormal profits in the

long run, because barriers to entry prevent

sideline firms from entering market to capture

excess profits.

Potential to Differentiate

1. Differentiation

possible, firms can

shape their own

environment

2. Technology keeps

evolving

3. Minimum efficiency

scale needed

Given the industry structure, Castrol has got its strategy right

Cost Advantage

High Price

Elasticity

Modest price cuts gain considerable share

Margin strategy: Maintain price parity

Product Advantage

Modest hikes lose considerable share

Margin strategy: Maintain price parity

Low Price

Elasticity

Big price cuts gain little share

Margin strategy: Maintain price parity

Big price cuts gain little share

Margin strategy: Charge premium price

Source: MOSL

30 July 2012

Castrol India

Has created an enduring and widening moat

High pricing power; less dependent on volume growth



Despite intense competition in the lubricants industry in the last decade, Castrol has been

able to successfully create and appropriate value through adept market segmentation.

Castrol's primary market is premium personal mobility automobiles, where it is able to

leverage its trusted brand, product track record and unique service attributes.

Unlike its competitors that have been making low to negligible investments in their brands,

Castrol has consistently been investing 6-7% of its sales (INR2.2b in CY11) in brand-building.

Over CY01-11, Castrol's sales volumes have declined. However, its realizations have grown

at a CAGR of over 10%, resulting in sales CAGR of 9%.

Enjoys higher than industry average profitability...

Enjoys tremendous

pricing power, with most

of its products

commanding 20-25%

premium

Despite intense competition in the lubricants industry in the last decade, Castrol has

been able to successfully create and appropriate value through adept market

segmentation. Over CY06-10, Castrol has consciously vacated non-profitable price-

sensitive segments such as railways, government agencies, etc, to concentrate on

profitable segments. While this resulted in volume growth being negative over CY05-

11, EBIT margin increased from ~14.5% in CY05 to 20.5% in CY11. The company enjoys

tremendous pricing power, with most of its products commanding 20-25% premium.

Castrol's primary market is the premium personal mobility segment, where it is able

to leverage its trusted brand, product track record and unique service attributes.

...which should sustain, given multiple and rare moats

Has maintained an

average net profit margin

of 12% and an average

RoE of 53%

Over CY01-11, Castrol has maintained an average net profit margin of 12% (lowest:

8.6%; highest: 17.5%) and an average RoE of 53% (lowest: 35%; highest: 94%). It

generated free cash flow (FCF) of INR27b, with total net capex of a negative INR408m.

Castrol has been able to sustain its above average returns by virtue of the multiple

and rare moats it has created. The width of a moat indicates how long a firm's

competitive advantage will last. Most moats a company enjoys turn out to be weak or

transient, leading to the convergence of its profitability with competitors'. Few rare

companies, however, are able to secure enduring and widening moats, enabling them

to avoid this downward spiral. As such companies age, they also become stronger and

more profitable. Castrol is one such company. Its sustained performance over the last

decade highlights the strength of its inimitable model.

Castrol enjoys multiple and rare moats

High

(1) Increasing returns

advantages



Cumulative experience across a learning curve

Ability to invest in a series of actitivities to gain

strategic fit and widen competitive moat

Support from parent BP

Product performance track record and reputation

Quality pre/post sales service

(2) Technology and knowledge

base

(3) Established brand/

Enduring relationships

(4) Ability to create

uniqueness in drastically

different ways



Allows Castrol to operate in the high willingness to

pay/defendable and meaningful subset of the market



Charge 20-25% premium on its products



Leverage on its wide distribution network



Low

Introduce paradigm breaking new product concepts

Compelling advertisement messages

Source: MOSL

30 July 2012

Castrol India

Castrol has got its strategy right

Cost Advantage

High Price

Elasticity

Modest price cuts gain

considerable share

Margin strategy:

Maintain price parity

Big price cuts gain

little share

Margin strategy:

Maintain price parity

Product Advantage

Modest hikes lose

considerable share

Margin strategy:

Maintain price parity

Big price cuts gain

little share

Margin strategy:

Charge premium price

Lube price premium

+25%

Castrol

Mobil Esso

PSUs (IOC, HPCL, BPCL)

Gulf / Veedol

Low Price

Elasticity

-10%

Others

Source: MOSL

Expect pricing premium over industry to stabilize at 20-25%

Has managed to create

and sustain a wide gap

between buyers'

willingness to pay (WTP)

and its cost

The industry players can be broadly divided into three categories: (1) low cost public

sector operators like IOC, BPCL and HPCL, with ~70% market share (lower cost due to

integrated model), (2) differentiators like Castrol, Shell and Total, focused on

increasing WTP, and (3) mid-sized/small players lacking competitive advantage - these

players compete with low cost players for market share to sustain minimum economies

of scale. Through its differentiation strategy, Castrol has managed to create and sustain

a wide gap between buyers' willingness to pay (WTP) and its cost.

Player-wise positioning in the lubricants industry

INR

Low Cost

Operator

Industry

Average

Differentiator

Industry Average

WTP

Buyer

Surplus

WTP

Buyer

Surplus

Buyer

Surplus

WTP

Firm

Surplus

Industry

Average

Cost

Firm

Surplus

Cost

Firm

Surplus

Cost

IOC/HPCL/BPCL

*WTP - willingness to pay

Others

Castrol/MOBIL

Source: MOSL

Historically, Castrol has enjoyed 20-25% price premium vis-a-vis its competitors.

However, in CY11, Castrol's price premium compared to its key competitors had shot

up to 35-40% in some segments, because the competitors did not immediately follow

up on the sharp price increase (~14%) that Castrol took to offset raw material and

exchange rate (INR/ USD) impact. This resulted in the trade stocking cheaper products,

which led to loss of market share of ~200bp for the company, with the price-sensitive

motorcycle segment being the worst impacted. With IOC taking a sharp 10-12% price

increase in June 2012 and Castrol introducing a one-time INR20/pack discount for the

motorcycle segment, the issue of unsustainable premiums has been resolved.

30 July 2012

Castrol India

Consistently investing in brand-building to sustain pricing power

Has consistently been

investing 6-7% of its sales

in brand-building

Castrol's differentiation strategy provides it with tremendous pricing power and high

profit margins. In CY11, its net profit margin was 15.6%, and over CY06-11, its average

net profit margin was 13.4%. Over CY06-11, Castrol's realizations increased at a CAGR

of 12.8%, while its raw material cost, which accounts for ~50% of its sales, increased at

a CAGR of 7.9% (total cost grew at a CAGR of 8.9%). Castrol invests heavily in its brands

to sustain its pricing power. Unlike its competitors that have been making low to

negligible investments in their brands, Castrol has consistently been investing 6-7%

of its sales (INR2.2b in CY11) in brand-building.

Castrol spends heavily on brand building

Adv. Expense

Low price elasticity

Negative correlation of -0.35

Sharp increase in prices results in low volume loss (%)

Source: Company/MOSL

Strategy to maintain competitive edge

Castrol maintains its competitive edge in the bazzar trade by: (1) leveraging its

technological strength and product development capabilities by working closely

with global OEMs, (2) working closely with mechanics, who play a key role in the

final decision making, and (3) by expanding distribution reach in semi-urban and

rural areas, where future growth is anticipated. Castrol has been coherent in the

communication of its value proposition to the consumer. Its key advertisement

plank has been 'Liquid Engineering'.

Castrol's three-pronged strategy

Brand

Globally, Castrol is one of the strongest lube brands

Technology

Customer Relationships

Source: BP Energy Outlook Presentation 2030

30 July 2012

Castrol India

Castrol has been coherent in its communication

Few paradigm breaking new product concepts by Castrol



Engine that runs smooth like butter



Engine oil that runs like blood through the

vehicle



An indication of good engine oil is the sound

that the bike makes



Engine is the heart of the vehicle



24 Hour Protection (bikes)

Intelligent Molecules (cars)

5 Times Better Protection (cars)

Elite Team of Engineers (mother brand)

Trizone Technology (bikes)

CRB Turbo Synthetic - Airplane Technology

(trucks)

Source: MOSL

High technological support from parent, BP to continue

Non-OECD/BRIC countries are likely to be the fastest growing markets for lubricants

over CY10-30. Growth is likely to be led primarily by India and China, where vehicle

density per person is still very low. While vehicle per thousand people is expected to

witness marginal to flat growth in developed countries, countries like India and China

are expected to witness increasing vehicle density per person, which augurs well for

lubricant demand. Castrol's parent, BP has identified India as one of the most

promising markets. We expect Castrol to continue receiving high support from BP.

Non-OECD countries to witness fastest growth

Total number of vehicles

Vehicles per thousand people

Growth in lubricant demand (2010-20)

BP's key focus area is premium lubes

Growth in lubricants (2010-20)

Premium lubes as percentage of sales

Relative BP unit margins (x)

Source: BP Energy Outlook Presentation 2030; BP Downstream Presentation

30 July 2012

Castrol India

The Indian lubricants industry - a background

Market size:



INR230b in value terms



1.8mt in volume terms



Liberalization effect:

Year Share of PSU pumps

1990

~80% of auto lube

sales

Now

~20% of auto lube



sales



Oil PSUs and Castrol

together control ~80% of

the market



Castrol primarily present

in automotive lubricants



The size of the organized lubricants industry in India is ~INR230b in value terms

and ~1.8mt in volume terms. Volumes have been growing at 3-5% per year, as

the drainage period (longevity) has been continuously increasing. Till 1993, the

lubricants industry was governed under APM (administered price mechanism),

which ensured oil PSUs 12% RoE. Lubricants were auctioned to dealers and

stockists. The business was liberalized in 1993, post which import of base oil was

allowed. The customs duty on base oil was also cut from 85% in FY94 to 5% in

FY08.

Even after liberalization, access to 'retail petrol pumps' (distribution channel)

remains restricted to the oil PSUs. Nonetheless, while in the late 1990s, PSU

petrol pumps accounted for ~80% of auto lube sales, they now account for less

than 20%. The bazzar trade accounts for over 80% of sales and is dominated by

private players such as Castrol, Shell, Tide Water and Gulf Oil.

The oil PSUs have been milking their monopoly strength through petrol pumps.

They have been offering very low dealer discounts to their petrol pump dealers

compared to the dealer margins that private players offer in the bazzar segment.

However, the oil PSUs have now started making a more focused attempt to capture

a larger share of the bazzar trade.

The oil PSUs (IOC, HPCL and BPCL) along with Castrol control ~80% of the market,

with 15 other players competing for the remaining pie. Competition in this

industry is truly international, with almost all major global lube players such as

Total, Shell, Caltex, Elf, Gulf Oil, etc already present in India for almost a decade.

Economies of scale are a key advantage in this industry, which is slowly weeding

out mid-sized players and increasing polarization.

The industry can be broadly divided into Automotive (55% share) and Industrial

& Marine (45% share) lubricants. Automotive lubricants can be further divided

into the OEM and replacement markets. The replacement market can be divided

into retail petrol pumps (~20%) and bazzar trade (~80%). Castrol is primarily present

in automotive lubricants (~86% of revenue) and has an estimated market share

of ~21%.

Region-wise sales break-up of automotive lubes

Lubricants industry break-up

Petrol

30%

Diesel

70%

Broad break-up of automobile industry demand:

diesel engines ~70% and petrol engines 30%. With the

proportion of new generation two-wheelers increasing, the demand for 2T oils is reducing and the demand

for 4T oils is increasing.

Source: Industry/MOSL

30 July 2012

Castrol India

Key industry players

Top-4 lubes players volume-wise and value-wise

('000 kl)

(INR b)

The top-4 lubes players in India are IOC, HPCL, BPCL

and Castrol. With the exception of BPCL, they have

witnessed erratic volume growth over FY09-11.

Split of market share within PSU lube sales

Reasonable pricing power allows companies to

increase prices and maintain value growth.

Realizations for top-4 players

(INR/kl)

The three oil PSUs control ~70% of the market. Within

them, market share is distributed as: IOC - 45%, HPCL

- 28% and BPCL - 26% (FY11).

Monopoly control over the 'retail petrol pumps'

distribution channel allows oil PSUs to enjoy very

high margins on the lubes sold through this channel.

Castrol enjoys premium pricing.

Realizations also vary amongst players, depending on

the split between industrial and automotive

lubricants.

Source: Annual Reports of IOC/ HPCL/ BPCL and Castrol

30 July 2012

Castrol India

Industry structure: A differentiated oligopoly market

Differentiated Oligopoly market

Top four players IOC/ HPCL/ BPCL and Castrol

control >80% of the market

Nature of Demand

1. Endogenous demand -

marketing matters

2. Earnings can be

managed by shifting

priorities appropriately

Nature of Firm Interaction

1. High interdependence amongst players

2. Maintaining distance amongst competitors

critical - segmentation matters

3. Oligopolies can retain abnormal profits in the

long run, because barriers to entry prevent

sideline firms from entering market to capture

excess profits.

Potential to Differentiate

1. Differentiation

possible, firms can

shape their own

environment

2. Technology keeps

evolving

3. Minimum efficiency

scale needed

Analyzing industry attractiveness through industry competition matrix

Buyer Power - Low

1. Lubricant a small fraction of buyers' maintenance cost, but extremely

critical for longevity of the vehicle

2. Buyers small and fragmented

3. Hence, despite intense competition in the segment, buyer power varies

from moderately high to low across segments (high for a major auto

OEM, low for an individual buyer, small fleet owner)

Entry Barriers - High

Ex post limit to

competition

High minimum economies

of scale needed to

challenge established

players; globally, industry

dominated by few large

players

Access to distribution

Brand identity

Access to complex and

expensive technology

Rivalry amongst Players - Low

Intensity of rivalry is low, despite presence

of numerous players and the fact that

firms sell similar goods, which are

substitutes and thus price sensitive.

Key reasons are (1) fixed cost

investment low (low exit barriers),

(2) ex post limit to competition,

(3) demand endogenous - allowing

market segmentation and

differentiation strategies to work

Substitutes - Low

1. No current perfect

substitute

2. Technology

developments, organic

lubricants a threat

Bargaining Power of Suppliers - Moderate

1. Most global/ local players fully integrated

2. Many competitive suppliers; product is standardized

Source: MOSL

30 July 2012

Castrol India

To benefit from industry transition

From 'shops' to 'workshops' - advantage Castrol



During the last decade, the distribution channel for automotive lubricants (lubes) witnessed

a major transition from the traditional 'public sector petrol pumps' to 'bazzar trade',

which was positive for private sector players such as Castrol, Shell and Gulf Oil.

The distribution channel is now undergoing another transition. With engine technology

advancing and maintenance becoming more sophisticated, the workshop channel is gaining

traction at the cost of other distribution formats.

This is likely to lead to further polarization in the industry and benefit large lube marketers

like Castrol that have strong/established relationships with OEMs.

Transition from 'shops' to 'workshops' positive for Castrol

The workshop channel is

gaining traction at the

cost of other distribution

formats

During the last decade, the distribution of automotive lubes witnessed a major

transition from traditional 'public sector petrol pumps' to 'bazzar trade', which was

positive for private players such as Castrol, Shell, Gulf Oil, etc. Another transition is

currently underway - from 'shops' to 'workshops'. With engine technology advancing

and maintenance becoming more sophisticated, the workshop channel (both company

authorized and unorganized) is gaining traction at the cost of other distribution formats.

As a result, we expect the following trends to emerge:

Increase in the share of the organized market



Higher polarization, with market share of the top-4 lubricant marketers (Oil PSUs

and Castrol) increasing at the cost of mid-size and non-niche smaller players



Technological innovation, value-addition, quality, and pre/post-sales service to

become critical



Focus on innovative/premium product offerings leading to richer product mix



Launched a professional

range of products and

service support for key

OEM partners

These trends are positive for Castrol. It can further leverage its premium positioning

and established relationships with key local and global OEMs (original equipment

manufacturers). Anticipating these trends, in CY11, Castrol had launched a professional

range of products and service support for its key OEM partners like Maruti Suzuki, Tata

Motors, Ford, Volkswagen, Skoda, BMW, Audi and Jaguar Land Rover. This is likely to

drive significant volume growth for its premium end of lubricants.

Distribution of automotive lubricants

Automotive Replacement Market

Retail Oil PSUs (18-20% of market)

Bazzar Trade (80-82% of market)

Auto Spare Parts

(50%)

Repair Shops

(9%)

Lube Shops

(21%)

Company Workshops

(9%)

Others

(11%)

Source: Industry/MOSL

30 July 2012

Castrol India

Understanding the distribution channel - the lubes market is evolving

Distribution channels

Spare Parts Shop for Autos

Market Share (%)

Remarks



Main business auto spare parts, offer

lubricants as side business



Do not stock many varieties



Dedicated lube shops typically carry all

leading brands



Do-it-yourself model but offer mechanic

service for additional cost. Do-it-yourself

model slowly declining



Important channel for older vehicles



High focus on technology and maintaining

efficiencies



Association with top brands brings

credibility for the CAW



ROI on premium products higher for CAW



Prefer companies that offer pre and post

sales service, along with innovative

offerings



Varied usage

Source: Industry/MOSL

Standalone Lubricant Shops

Repair Shops

Company Authorized

Workshops (CAW)

Others

Total

100

OEM relationships key to winning in workshop format

Though profit margins are low in the OEM market, strength in this market gives

lubricant companies easier access to the after sales market. According to industry

estimates, the dominant distribution channel for lubricants is the auto spare parts

shop, accounting for ~50% share. However, it is the company authorized workshop,

currently accounting for just 9% share, which is witnessing the strongest growth. This

channel seeks association with strong brands to achieve creditability and values pre/

post sales service from lube companies. Also, the margins for these workshops are

higher in the premium products/brands segment.

Automotive industry break-up

Castrol's automobile lubricant break-up

Almost 75% of the lube demand is derived from CVs

and tractors, largely dominated by diesel engines.

2/ 3 wheelers account for another ~13% of the

market, while 4 wheelers/ MUVs account for ~5% of

the market

Source: Industry/MOSL

30 July 2012

Castrol India

Castrol the market leader in bazzar segment

Dominates the

automotive lubricants

market, with 19% share

of the bazzar segment

IOC is the market leader in the overall lubricants industry, with industry sources

estimating its market share at ~40%. However, Castrol dominates the automotive

lubricants market, with 19% share of the bazzar segment, followed by IOC, which has

~14% share of the bazzar segment according to industry estimates. Private players

like Castrol, Shell, Gulf Oil, etc account for ~75% of the bazzar segment while the oil

PSUs account for ~25%.

Industry estimates of Castrol's market share across key

categories in bazzar segment

Player-wise industry estimates of

market share in bazzar segment

Source: Industry/MOSL

Has been coherent in the

communication of its

value proposition to the

consumer

Castrol maintains its competitive edge in the bazzar trade by: (1) leveraging its

technological strength and product development capabilities by working closely with

global OEMs, (2) working closely with mechanics, who play a key role in the final

decision, and (3) by expanding distribution reach in semi-urban and rural areas, where

future growth is anticipated. Castrol has been coherent in the communication of its

value proposition to the consumer. Its key advertisement plank has been 'Liquid

Engineering'.

Focused strategies for various segments

While lubricants constitute a small fraction of maintenance cost, they are critical for

longevity and efficient functioning of vehicles. Hence, demand is endogenous and

brand-pull significant. However, the consumer dynamics and distribution channels

vary considerably across automotive segments. While the involvement of a car owner

in lube purchase is very low, it is very high in case of a two-wheeler or CV owner.

Similarly, the key distribution channel also varies considerably across segments.

Consequently, lube companies need to have focused strategies for various segments.

30 July 2012

Castrol India

Understanding the distribution channel - the lubes market is evolving

Vehicle

Trucks/ Tractors

Main Distribution Channel



Petrol Pumps



Company Salesman



Spare Parts Shops



Company

Authorized

Workshops



Retail Petrol Pumps



Mechanics/

Workshops

(Spare Parts Shops &

Distributors)



Mechanics (Distributors)



Spare Parts Shop

Remarks/ Characteristics



High emotional connect to the vehicle

(bread earner)



Meticulous understanding of lubes

and vehicle



Brand pull significant but economy

biggest driver



Very low involvement with purchase

decision



Lubes regarded as mechanics'

domain and left for them to decide



Level of involvement high with regard

to choosing lube oil



Lube experience real



Emotional connect high given first

vehicle purchase, status symbol



Price key determining factor



Unorganized segment key player

Source: Industry/MOSL

Car Owners

2 wheelers

(2 stroke/ 4

stroke)

Agriculture/

Others



Small Shops and

Unconventional Outlets

Understanding the lube oil demand profile for a typical CV

The exhibit below depicts the typical lube oil demand profile for a CV. Players such as

Castrol are able to capture a bigger share of the market within the first five years by

leveraging on their OEM relationships and after sales service agreements. The age

and nature of ownership of a CV determine what quality (and brand) of lube oil will

be used. In India, a CV is typically owned by large fleet operators for the first 4-5

years, after which it moves into the hands of many fragmented users. The share of

the unorganized market is higher for older vehicles.

Product life-cycle of a typical 16-tonne CV

Through

various

innovative

schemes, OEM

service

workshops,

gaining

incremental

Competition

most severe

amongst

organized

players

Organized Market

- Low price

products

- Unorganized

segment

1-3 years

3-6 years

Years

7-10 years

Source: Industry/MOSL

30 July 2012

Castrol India

Margin/unit to sustain

Though volume growth to be muted



Over CY01-11, Castrol's sales volumes have de-grown, not only due to increasing drain

interval, but also because it has deliberately vacated the price-sensitive volume-driven

market.

We estimate 2.4% CAGR in Castrol's volumes over CY12-14. However, revenue would

grow at a CAGR of 9%, driven by 6% CAGR in realizations.

We expect EBIT margin to expand from 19.5% in CY11 to 22.2% in CY13 and estimate net

profit CAGR at 17% over CY12-14.

Volumes have declined over CY01-11

Though volumes

declined, net profit

margin expanded from

12% in CY02 to 15.6% in

CY11

Over CY01-11, Castrol's sales volumes have de-grown at a compounded annual rate of

0.8%. However, revenue has grown at a CAGR of 9%, driven by realization CAGR of

10%. The negative volume growth is not only due to increasing drain interval (up from

~18,000km in FY04 to 30,000km for modern 16-tonne CV), but also because Castrol has

deliberately vacated the price-sensitive volume-driven market. Castrol's net profit

margin expanded from 12% in CY02 to 15.6% in CY11. The company has been focusing

on improving its product mix through adept market segmentation and innovative

products. How effectively Castrol is able to continuously improve its product mix by

consistently expanding the premium end of the market and through paradigm-

breaking new product concepts is a key factor to watch.

Revenue and realization growth over CY00-11 (%)

Volume growth over CY00-11 (%)

Source: Company/MOSL

Management growth outlook for key segments

The management has guided for auto lube volume growth of 2-2.5% over the next 3-

5 years. Castrol's auto lube sales break-up: diesel engine oils (mostly CVs) 40%,

2-wheelers 20%, passenger cars 15% and OEM/ Construction/ Brake oil, etc 25%. The

management expects the 2-wheeler segment to double in volume terms in the next

3-4 years, while the other segments will likely post marginal growth rates. The

management expects growth in the industrial segment to be marginally stronger

than in the auto segment.

30 July 2012

Castrol India

Management growth outlook

Company growth outlook over

% CY12-15

40 Expects very low to marginal

growth

2-Wheelers

20 Expects volumes to double in

3-4 years

Passenger Cars

15 Expects 1% odd growth

OE/ Const/ Others

25 Marginal growth

Total

100 2-2.5% growth

Source: Conference Call post 3QCY11 results

Castrol auto volume

break-up

Diesel Engine Oils

Automobiles: Segment-wise sales break-up

Source: Company/MOSL

Expect volumes to grow at a CAGR of 2.4% over CY12-14

We expect volume growth for lubricants industry to remain muted, given technological

advancements and increasing drain intervals. We estimate 2.4% CAGR in Castrol's

volumes over CY12-14.

Raw material cost assumptions

2008

Base Oil

Volumes ('000 tons)

% Change

Value (INR m)

% Change

Per Unit (INR/kl)

% Change

% of lube sales

Additives/ Chemicals

Volumes ('000 tons)

% Change

Value (INR m)

% Change

Per Unit (INR/kl)

% Change

% of lube sales

Total Raw Material Cost (INR m)

Base Oil (%)

Additives (%)

Others (%)

% of sales

182,293

-6

8,880

48.7

32,494

-3.6

3,153

13,125

2009

176,838

-3

6,477

-27

36.6

-25

32,429

-0.2

3,363

104

11,238

2010

187,463

8,624

46.0

31,825

-1.9

3,554

112

13,847

2011

168,911

-10

10,433

61.8

30,076

-5.5

3,959

132

16,945

2012E

174,637

3.4

11,757

9.0

30,613

1.8

4,392

143

9.0

18,820

2013E

178,828

2.4

11,859

-1.5

2014E

183,299

2.5

12,787

5.2

31,347

32,131

2.4

2.5

4,430

4,777

141

149

-1.5

5.2

19,166

20,711

Source: Company/MOSL

30 July 2012

Castrol India

High sensitivity to volume and realization assumptions

Castrol has high sensitivity to volume and realization assumptions. We have assumed

volume/realization CAGR of 2.4%/ 6% over CY12-14, implying revenue growth of ~9%.

Our volume and realization assumptions over CY12-21 are 2.6% and 7%, respectively.

Over CY01-11, Castrol has reported volume and realization CAGR of -1% and 10%,

respectively. Negative volume growth over CY01-11 was primarily due to Castrol

vacating the price-driven volume market. BP estimates (BP Refining and Marketing

Presentation) BRIC countries to be the largest lubricant market by 2020, given low

vehicle penetration. Furthermore, within the lubricant industry, BP expects premium

lubricants to grow at a faster rate compared to normal lubricants. Consequently, we

believe our assumption of 2.6% volume growth for Castrol is conservative and has

potential for upside surprise.

Sensitivity of net profit and DCF (value/share) to volume growth and realization growth

Change

(+/-)

Volumes

Base (%)

Optimistic (%)

Pessimistic (%)

-1

PAT (INR b)

Optimistic (INR b)

+1%

% Change

Pessimistic (INR b)

-1%

% Change

Realization

Base (%)

Optimistic (%)

Pessimistic (%)

-1

PAT (INR b)

Optimistic (INR b)

+1%

% Change

Pessimistic (INR b)

-1%

% Change

Both Volume and Realization

Base (%)

Optimistic (%)

Pessimistic (%)

-1

PAT (INR b)

Optimistic (INR b)

+1%

% Change

Pessimistic ((INR b)

-1%

% Change

Raw Material

Base (%)

Optimistic (%)

-1

Pessimistic (%)

PAT (INR b)

Pessimistic (INR b)

+1%

% Change

Optimistic (INR b)

-1%

% Change

2012E

2.1

3.1

1.1

4.6

0.8

4.5

-0.8

4.7

5.7

3.7

4.7

3.2

4.4

-3.2

6.8

9.0

4.8

4.7

4.0

4.4

-3.9

9.0

8.0

10.0

4.5

-2.4

4.7

2.4

2013E

2.4

3.4

1.4

5.7

1.7

5.5

-1.7

5.2

6.2

4.2

5.9

5.8

5.3

-5.7

6.7

9.8

5.7

6.0

7.6

5.2

-7.3

-1.5

-2.5

-0.5

5.4

-4.2

5.9

4.2

2014E

2.5

3.5

1.5

6.5

2.6

6.1

-2.6

6.7

7.7

5.7

6.8

8.7

5.8

-8.6

8.3

11.5

7.3

7.0

11.6

5.6

-10.9

5.2

4.2

6.2

5.9

-6.2

6.7

6.1

2015E

2.7

3.7

1.7

7.3

3.6

6.8

-3.5

6.9

7.9

5.9

7.9

11.6

6.3

-11.3

8.8

11.9

7.7

8.2

15.7

6.0

-14.4

5.2

4.2

6.2

6.5

-8.2

7.6

8.0

2016E

2.7

3.7

1.7

8.3

4.7

7.5

-4.6

6.9

7.9

5.9

9.1

14.6

6.8

-14.1

8.7

11.9

7.7

9.5

20.1

6.5

-18.0

5.2

4.2

6.2

7.1

-10.2

8.7

9.8

2017E

2.7

3.7

1.7

9.4

5.9

8.4

-5.6

6.9

7.9

5.9

10.4

17.6

7.4

-16.8

8.7

11.9

7.7

11.1

24.5

7.0

-21.6

5.2

4.2

6.2

7.8

-12.1

9.9

11.5

2018E

2.7

3.7

1.7

10.7

7.2

9.3

-6.8

6.9

7.9

5.9

12.0

20.6

8.0

-19.6

8.7

11.9

7.7

12.9

29.2

7.5

-25.1

5.2

4.2

6.2

8.9

-14.0

11.3

13.2

2019E

2.6

3.6

1.6

12.2

8.4

10.3

-7.9

6.9

7.9

5.9

13.9

23.6

8.7

-22.2

8.7

11.9

7.7

15.0

33.9

8.0

-28.6

5.2

4.2

6.2

9.4

-15.8

12.9

14.8

2020E

2.6

3.6

1.6

13.9

9.8

11.5

-9.1

7.0

8.0

6.0

15.9

26.6

9.5

-24.8

8.7

11.8

7.6

17.5

38.7

8.6

-32.0

5.3

4.3

6.3

10.4

-17.5

14.7

16.3

2021E

2.5

3.5

1.5

15.7

11.2

12.7

-10.3

7.0

8.0

6.0

18.3

29.7

10.3

-27.5

8.7

11.8

7.6

20.3

43.7

9.1

-35.4

5.3

4.3

6.3

11.4

-19.2

16.6

17.8

CAGR

2.6

3.6

1.6

14.6%

12.1%

680

8.1

582

-7.5

DCF

Value

6.7

7.7

5.7

16.3%

9.8%

699

11.1

564

-10.3

9.48

11.58

7.4

17.5%

8.5%

756

20.2

522

-17.0

4.5

3.6

5.5

608

-3.3

650

3.3

Source: MOSL

30 July 2012

Castrol India

Decline in raw material prices could boost margins

Historically, base oil prices have closely followed crude oil prices, with correlation at

0.93x. In the last three months, crude oil prices have declined by 18% in USD terms,

which bodes well for Castrol. The exhibit below depicts Castrol's spread between

lube oil realizations and base oil prices.

Spread between Castrol's base oil and lube oil prices

Base oil prices follow crude prices with a lag (INR/bbl)

Crude oil

Correlation of 0.83x

Correlation of 0.93x

Base oil

Source: Bloomberg/MOSL

CY09 and CY10 were very strong years for Castrol; it retained the price increase it had

taken on the back of higher raw material prices even after the prices declined. Also,

Castrol has already taken marginal price increases in CY12 to cover itself for the sharp

rupee depreciation and increase in base oil prices. Even if base oil prices decline from

current levels, Castrol might retain its enhanced product prices. We model ~11%

increase in Castrol's blended base oil cost in CY12. Castrol imports ~40% of its raw

material requirements.

Given high pricing power,

price clycity is positive

Raw material cost accounts for 50-55% of Castrol's sales. Most of its raw materials are

crude based and hence very volatile. Nonetheless, given Castrol's high pricing power,

we have summarized the impact on Castrol based on various scenarios. While a secular

upturn in prices is bearish and a secular downturn is bullish for Castrol. Contrary to

popular belief, price cyclicity is positive for Castrol, given its high pricing power.

Scenario outlook for raw material

Scenario

Secular Increase in Base oil prices

Outlook

Bearish

Comments

Likely to impact demand, lead to down

trading and increase use of alternate or

substitutes (CY06)

Most positive scenario as it would boost

demand, while companies like Castrol

can apportion some part of the decline

and increase margins

Bearish as ability to make major price

changes limited

Positive as a company like Castrol

due to its pricing power can pass on price

increases, while apportioning part of

savings when prices fall (CY09-10)

Source: MOSL

Secular Fall in Base Oil Prices

Bullish

Stagnant Base Oil Prices

Cyclical Base Oil prices

Moderate

Bearish

Moderate

Bullish

30 July 2012

Castrol India

Has maintained net margin per unit, negating increasing drain intervals

Over the last decade, the lubricants industry has been witnessing significant

technological advancement and increasing use of semi-synthetic products, which has

steadily increased drain intervals (longevity). For instance, the average drain interval

for a typical 16-tonne CV, which was ~8,000km in CY03, stood at ~18,000km in CY11,

implying a CAGR of 10.7%. As a result, the lubricants industry has grown at just 3-4%

during the last decade. Though Castrol has witnessed a volume decline during the

period, it has managed to maintain its net margin per unit.

Castrol's net spread (margin/kl, INR)

Net margins spread

CY (Year)

Net Lubricant

Spread (Margin/ Kl)

Drain adjusted

Spread/ Kl

Drain interval

Adjusting for the

drain Impact

CAGR Growth

2003

8,000

1.00

2004

9,250

1.16

2005

9,458

1.18

2006

2007

2008

2009

2010

2011

9,750 10,188 10,917 12,375 16,750

18,000

1.22

1.27

1.36

1.55

2.09

2.25

10.7%

We have assumed a CAGR growth of ~8% for drain interval over CY12-15 and modeled

Castrol to negate the impact of increasing drain intervals and maintain its Margin/

Unit over FY12-15.

Net margins spread

CY (Year)

Net Lubricant Spread (Margin/ Kl)

Drain adjusted Spread/ Kl

Drain interval

Adjusting for the drain Impact

CAGR Growth (%)

2011

18,000

2.25

10.7

2012E

57.7

19,440

1.1

8.0

2013E

60.9

20,995

1.2

8.0

2014E

61.5

22,675

1.3

8.0

2015E

61.4

24,489

1.4

8.0

Source: MOSL

30 July 2012

Castrol India

Expect Castrol to maintain margin at ~INR60/kl over CY12-15

Source: MOSL

Volume decline (YoY) arrested in 2QCY12

Registered 4.8% YoY

volume growth in

2QCY12

Castrol registered four consecutive quarters of YoY volume decline, over 2QCY11-

1QCY12. This was on the back of Castrol undertaking price increase of ~14% in CY11 to

negate the impact of raw material price increases. Traditionally, Castrol has been the

price decider in the domestic lubricant market, with competitors following its

footsteps. However, in CY11, its key competitors did not follow up with price increases

immediately, which resulted in Castrol's premium over its competitors increasing

from the historical range of 20-25% to 35-40% for a period of about six months. This

resulted in Castrol losing 2-3% market share, with the 2-wheeler segment getting

most adversely impacted. This anomaly got corrected in June 2012, with market leader

IOC taking a 10-12% price hike and Castrol launching a promotional discount scheme

of INR20/pack for its 2-wheeler lubricants. As a result, Castrol's volume growth was

arrested in 2QCY12, with the company registering a 4.8% volume growth.

Castrol's OoQ volumes are cyclical (MT)

Castrol's YoY change in volumes (%)

Source: Company/MOSL

30 July 2012

Castrol India

Market to witness addition of 16m premium vehicles over FY13-15

The overall automobile lubricant market is likely to witness addition of ~76m vehicles,

over FY13-15. Nevertheless, the premium personal mobility segment, which is Castrol's

focus area is likely to grow at a faster pace. The premium mobility segment, comprising

of cars (A3 and above) and 4-stroke 2-wheelers (>125cc), is expected to report a

cumulative CAGR of 19% over FY11-15 and witness new additions of ~15.6m vehicles.

With increasing sales of premium vehicles, the overall market for premium products

is set to expand meaningfully over the next 3-5 years. This should be a key positive

for Castrol, as it is clearly focused on this particular segment and best placed to

leverage this opportunity.

Auto industry growth outlook

'000 units

PC+UVs+MPVs

Three Wheelers

Two Wheelers

Total

Product Mix (%)

PC+UVs+MPVs

Three Wheelers

Two Wheelers

Total

Cumulative Market*

Total CV

Old Generation

New Generation

PC+UVs+MPVs

Three Wheelers

Two Wheelers

Total

% growth

% of 2 Wheelers

FY11

757

2,946

796

13,272

17,772

100

4,206

2,872

1,334

15,653

4,599

77,963

102,421

FY12

901

3,126

876

15,381

20,284

100

4,949

3,290

1,658

18,057

5,259

88,993

117,258

FY13E

998

3,438

920

16,919

22,276

100

5,744

3,845

1,899

20,716

5,904

100,852

133,217

FY14E

1,124

3,954

989

19,288

25,355

100

6,591

4,469

2,123

23,641

6,557

114,519

151,307

FY15E

1,279

4,547

1,038

21,988

28,853

100

7,523

5,119

2,404

26,960

7,221

129,933

171,637

Value added sales in personal mobility market

Cars above A3 segment

462

545

2W >125cc

3,092

3,574

Total

3,773

4,350

% Change

600

3,932

4,787

690

4,482

5,460

793

5,110

6,231

Cumulative value added sales in personal mobility market#

Cars above A3 segment 2,647

3,072

3,543

4,042

4,596

2W >125cc

13,920

17,494

21,139

25,139

29,729

Total

17,815

21,757

25,934

30,685

35,683

% Change

*We have considered life of vehicles as 10 years

Source: SIAM/MOSL

# We have considered passenger cars (A3 segment and above) and 2-wheelers (>125cc) as

premium personal mobility market.

30 July 2012

Castrol India

Typical usage of lube oil across vehicles

Lubricant usage is the highest in CVs (~93 liters per year for old generation CVs; ~48

liters per year for new generation CVs). Passenger cars require ~10 liters, while

two-wheelers require just ~4 liters a year. In case of two-wheelers, the lube oil is

typically changed ~5 times a year, given that the slump size of a motorcycle is only

one liter. Also, a high proportion of two-wheeler owners change lube oil on their

own. This could be the key reason for the high involvement of two-wheeler owners

in the purchase of lube oil.

Lube usage across vehicles in urban and semi urban areas

Drain Intervals

(Km)

15,000

30,000

5,000

2,100

Aprrox Slump

Size (Ltrs.)

0.9

Average Annual

Usage (Ltrs.)

Average Annual

Usage Times (x)

4.7

3.2

2.4

4.8

Usage

Per Year (Km)

70,000

95,000

12,000

10,000

Source: Industy/MOSL

Old Gen. CV

New Gen. CV

Cars

2 Wh. (4 St)

Product mix of vehicles

Total premium personal mobility vehicles ('000)

Average annual usage (KL)

Average annual usage times (x)

Drain intervals (KL)

Source: Industry/MOSL

30 July 2012

Castrol India

EBIT margins to improve from CY13

Expect EBIT margin to

improve from 18.6% in

CY12 to 22.2% in CY14

Castrol's EBIT margins have been under pressure in CY11 and 1HCY12, given pressure

from raw material and INR/USD. In CY11, base oil prices were impacted by external

issues such as trouble in the Middle East, fire outage at Formosa and national oil

companies taking shutdown. With crude prices under pressure (down 18% from its

CY12 peak), INR/USD expected to stabilize (our INR/ USD assumption for FY13 is 53.5)

and some other external issues getting resolved, we expect base oil prices to be

under pressure and model base oil prices at INR66/Kl (down 1.5%). This coupled with

realization improvement (4.7%/ 5.2% for CY12/ CY13) would boost CY13 margins by

308bp. We have modelled a 4.5% CAGR for raw material cost and 6.7% CAGR for per

unit realization over CY12-21. Realization improvement would be primarily driven by

new innovative product launches, improved product mix given move towards more

premium/ synthetic lubricants and technological advances. We have modeled Castrol's

EBIT margin to improve from 18.6% in CY12 to 22.2% in CY14.

EBIT movement over CY04-14 (INR m)

Source: Company/MOSL

Total cost break-up (%)

Source: Company/MOSL

30 July 2012

Castrol India

Expect advertisement and discount cost to remain at ~10% of sales

Source: Company/MOSL

Expect revenue CAGR of 9%, net profit CAGR of 17% over CY12-14

We expect Castrol to post revenue CAGR of 9% and net profit CAGR of 17% over CY12-

14. Revenue growth would be driven by 2.4% volume growth and 5.9% realization

growth. We expect EBIT margin to expand from 19.5% in CY11 to 22.2% in CY13 on the

back of lower raw material cost (55% of sales in CY11 to 52.9% in CY13), in turn driven

by declining base oil prices.

Revenue and net profit CAGR over CY11-14

Source: Company/MOSL

Castrol's FCF and payout over CY05-14

Castrol's RoE and RoCE over CY05-14

Source: Company/MOSL

30 July 2012

Castrol India

A cash machine for shareholders

FCF of INR27b over CY02-11; 87% paid out as dividend



Over CY02-11, Castrol generated FCF of INR26.8b, with total reinvestment of negative

INR3b.

Castrol's cumulative net capex (capex - depreciation) over the period was a negative

INR408m, while cumulative net working capital (net of cash) was a negative INR2.5b.

It has paid out 87% of its FCF as dividend.

FCF of INR27b over CY02-11; 87% paid out as dividend

Castrol has been a cash machine for its investors. Over CY02-11, it has generated free

cash flow (FCF) of INR27b, with total reinvestment of negative INR3b. Castrol's

cumulative net capex (capex - depreciation) over the period was a negative INR408m,

while cumulative net working capital (net cash) was a negative INR2.5b. Furthermore,

it has paid out 87% of its FCF as dividend, allowing shareholders to redeploy the cash

in other opportunities. Castrol has been able to achieve this performance by virtue of

its inimitable business model and by commanding very favorable terms of trade.

Summary of FCF over CY02 to CY11 (INR m)

Revenues

% Change

Net Profit

% Change

EBIT

% of Sales

% Change

EBIT(1-t)

Less: Total Re-investment

Depreciation

Capex

Net Capex (Capex- Dep.)

Change in WC

FCFF

Dividend Payout (with Tax)

% of PAT

% of FCF

Computed Variables

Total Capital Invested

Reinvestment

ROIC

2002

11,751

1,409

2,375

20.2

1,571

-1,818

134

116

-18

-1,800

3,389

2,238

159

1,440

2003

12,075

1,253

-11

2,067

17.1

-13

1,367

1,504

143

-116

1,620

-137

1,151

-842

2,944

1,504

2004

13,477

1,154

-8

1,980

14.7

-4

1,310

-354

249

-212

-142

1,664

1,155

100

2,590

-354

2005

14,645

1,348

2,135

14.6

1,412

341

189

-114

456

1,071

1,163

109

2,931

341

2006

18,025

1,545

2,018

11.2

-5

1,335

381

180

-86

468

953

1,269

133

3,312

381

2007

19,660

2,184

3,074

15.6

2,033

-2,186

208

244

-2,222

4,219

2,044

1,126

-2,186

181

2008

22,624

2,624

3,739

16.5

2,473

1,191

257

369

112

1,079

1,282

2,170

169

2,318

1,191

107

2009

23,906

3,811

5,480

22.9

3,625

-2,613

272

202

-70

-2,543

6,238

3,616

-295

-2,613

2010

28,020

4,903

7,006

25.0

4,634

-370

243

238

-6

-364

5,003

4,325

2011

30,821

4,810

-2

6,331

20.5

-10

4,187

1,018

251

318

952

3,169

4,311

136

Total

195,003

36,206

18.6

23,947

-2,905

2,126

1,718

-408

-2,496

26,852

23,441

-665

353

-370

1,018

1,186

Source: Company/MOSL

Expect FCF to remain robust over CY12-21, as well

We expect Castrol to repeat this performance over CY12-21, given that (a) industry

structure has become more conducive for large marketers like Castrol, (b) opportunity

size and growth is higher, and (3) its increasing returns advantage moat will allow it to

emerge stronger and bigger.

30 July 2012

Castrol India

Summary of FCF over CY12 to CY21 (INR m)

Base Year

Revenues

32,865

Net Profit

4,853

EBIT

6,106

EBIT(1-t)

4,189

- Reinvestment

1,018

Depreciation

251

Capex

318

Net Capex (Capex- Dep.) 67

Change in WC

952

FCFF

3,170

Capital Employed

6,042

New Investments

ROC

Dividend Payout (with Tax)

% of PAT

% of FCF

2012E

35,353

4,559

7,657

4,039

-226

301

300

-2

-224

4,266

5,816

-226

69%

4,325

101

2013E

38,579

5,612

8,580

5,066

-199

331

350

-218

5,265

5,617

-199

90%

5,046

2014E

42,256

6,283

9,690

5,677

-293

362

370

-301

5,970

5,324

-293

107%

5,767

2015E

46,280

7,044

10,894

6,411

-243

394

390

-4

-239

6,654

5,081

-243

126%

6,487

2016E

50,691

7,901

12,248

7,208

-150

430

435

-156

7,358

4,930

-150

146%

7,064

2017E

55,524

8,877

13,765

8,103

-319

468

460

-8

-311

8,422

4,611

-319

176%

7,929

2018E

60,819

9,966

15,476

9,107

-314

511

525

-328

9,421

4,297

-314

212%

8,938

2019E

66,613

11,201

17,467

10,239

-242

559

585

-268

10,481

4,056

-242

252%

9,803

2020E

72,929

12,624

19,540

11,556

-21

610

625

-36

11,578

4,034

-21

286%

10,956

2021E

Total

78,799 547,842

14,128 88,196

18,439 133,757

12,928 12,199

-412

-2,420

668

4,634

700

4,740

106

-444

-2,526

13,339

9,780

3,622

-412

357%

12,398

Source: MOSL

Key trigger for Castrol

will be higher than

expected volume growth,

without compromising

much on margins

Our assumptions for both volumes and realizations are conservative. We have

assumed that (1) growth in lubes industry volumes would be low at 2.6%, given

continuous technological advancement, (2) Castrol's relative market share will improve

by just ~2%, and (3) the retail petrol pump distribution channel, which we believe

will account for 12-20% of the market over the period, will remain out of reach for the

private sector players. We believe the key trigger for Castrol will be higher than

expected volume growth, without compromising much on margins. When

accompanied by high growth, companies that enjoy high cash flows, low risks and

require little capital command very high valuation multiples.

30 July 2012

Castrol India

Buy with a DCF-based target price of INR629, 17% upside

Huge free cash flows; valuations reasonable



Castrol provides a vehicle to invest in a company with multiple and rare moats, huge free

cash flow generation capability, high governance standards and reasonable valuations.

We expect Castrol to post earnings CAGR of 17% and FCF CAGR of 18% over CY12-14.

We initiate coverage with a Buy rating and a DCF-based target price of INR629, 17%

upside.

Expect Castrol to post

earnings CAGR of 17%

and FCF CAGR of 18%

over CY12-14

We expect Castrol to post earnings CAGR of 17% and FCF CAGR of 18% over CY12-14.

We have valued Castrol using (a) DCF methodology, and (b) intrinsic P/E and P/B

multiple. Given that Castrol is a tremendous FCF generator, has stable cash flows,

requires very low capex, and maintains a high payout ratio, we believe the most

appropriate way to value Castrol is through DCF. We recommend Buy with a DCF-

based target price of INR629. Our key assumptions are tabulated below.

Key assumptions

Valuation Inputs

Growth Period

Risk free Rate (Rf)

Levered Raw Beta (B)

Market Risk Premium (Rmp)

Cost of Equity: Rf+B(Rmp)

Stable Period

Risk free Rate (Rf)

Levered Raw Beta (B)

Market Risk Premium (Rmp)

Cost of Equity: Rf+B(Rmp)

India country Default Spread

Adjusted Risk free Rate (Rf)

Terminal Growth rate (Tg)

(%)

8.1

0.405

7.4

11.0

8.1

0.38

7.4

10.9

2.0

6.05

Comments

RBI 10 year G-sec Bond Yield

Bloomberg 1 year average Raw Regression Beta

Implied India Risk Premium based on Sensex

RBI 10 year G-sec Bond Yield

Bloomberg 10 year average Raw Regression Beta

Implied India Risk Premium based on Sensex

Bases on S&P Bond Default spread of 2% based on India's

BBB+ rating

Real Risk free rate in India

Real Risk free rate in India (Rf minus Country Default Risk)

Source: MOSL

Valuation summary

Method

Target Price (INR)

DCF CY13

629

Intrinsic PE and PB multiples CY13#

631

Upside (%)

Source: MOSL

30 July 2012

Castrol India

DCF valuation at INR629/share

We believe DCF is the best way to capture the intrinsic value of Castrol, given its

stable cash flow, stable growth profile and low capex requirement. We have done a

two-stage DCF valuation for Castrol. We have assumed revenue CAGR of 9% and net

profit CAGR of 12% over CY12-21. Our terminal growth rate assumption is the real risk-

free rate of return in India, which is calculated as the 10-year risk-free rate minus S&P

default spread for India, which is currently at 2%. Using the DCF methodology, we

arrive at a value of INR629/share.

DCF calculations (INR m)

Base

2011 2012E

2013E

7.6

35,353

21.7

7,657

2,591

5,066

331

350

-218

5,265

2014E

9.1

38,579

22.2

8,580

2,904

5,677

362

370

-301

5,970

2015E

9.5

42,256

22.9

9,690

3,279

6,411

394

390

-239

6,654

2016E

9.5

46,280

23.5

10,894

3,687

7,208

430

435

-156

7,358

2017E

9.53

50,691

24.2

12,248

4,145

8,103

468

460

-311

8,422

2018E

9.53

55,524

24.8

13,765

4,658

9,107

511

525

-328

9,421

2019E

9.54

60,819

25.4

15,476

5,237

10,239

559

585

-268

10,481

2020E

9.53

66,613

26.2

17,467

5,911

11,556

610

625

-36

11,578

Terminal

2021E

Year

9.48

72,929

26.8

19,540

6,612

12,928

668

700

-444

13,339

8.1

78,799

23.4

18,439

6,240

12,199

688

756

-236

12,368

258,036

33.8

10.8

Revenue Growth (%)

6.6

Revenues

30,821 32,865

EBIT Margin (%)

20.5

18.6

EBIT

6,331 6,106

Taxes

2,142 2,066

EBIT(1-t)

4,189 4,039

+ Depreciation

251

301

- Capital Expenditures 318

300

- Chg WC

952

-224

FCFF

3,170 4,266

Terminal Value

Cost of Capital Calculations

Tax Rate (%)

33.8

Cost of Equity (%)

11.0

Computed Variables

Total Capital Invested 6,276 6,050

Reinvestment Rate

0.24 -0.06

Return on Capital (%)

97.3

Present Value Calculations

Cumulative WACC

1.00

Present Value of FCFF

4,266

Present Value of Terminal Value

33.8

11.0

5,851

-0.04

126.6

1.11

4,743

33.8

11.0

5,558

-0.05

146.6

1.23

4,844

33.8

11.0

5,315

-0.04

174.3

1.37

4,863

33.8

11.0

5,165

-0.02

205.0

1.52

4,845

33.8

11.0

4,846

-0.02

237.2

1.69

4,996

33.8

11.0

4,531

-0.02

284.1

1.87

5,034

33.8

11.0

4,290

-0.02

341.5

2.08

5,044

33.8

11.0

4,268

-0.02

407.2

2.31

5,020

33.8

11.0

3,857

-0.02

457.8

2.56

5,210

100,774

Source: MOSL

Valuation

PV of FCFF during high growth phase =

PV of Terminal Value =

Value of Operating Assets of the firm =

Value of Cash & Non-operating assets=

Value of Firm =

- Value of Outstanding Debt =

Value of Equity =

Value of Equity in Common Stock =

Value of Equity per share =

Upside (%)

48,864

100,774

149,638

5,950

155,588

629

17.4%

Source: MOSL

30 July 2012

Castrol India

Sensitivity analysis

Terminal Growth and Cost of Equity (COE)

636

719

846

10%

596

672

789

COE (%)

11%

559

629

737

12%

525

590

689

13%

493

553

645

Source: MOSL

Terminal

Growth

5.05%

6.05%

7.05%

Sensitivity of DCF (value/share) to terminal growth rate

DCF (value/sh)

-1.5%

-1%

-0.5%

Base case

+0.5%

+1%

+1.5%

Source: MOSL

Growth beta and terminal growth

4.05

559

533

509

487

466

Terminal Growth Rate (%)

5.05

6.05

7.05

615

694

815

586

661

775

559

629

737

534

600

701

510

572

668

8.05

1023

970

921

875

831

Growth

Beta

0.20

0.30

0.40

0.50

0.60

Stable period beta and terminal growth

4.05

544

509

481

458

Terminal Growth Rate (%)

5.05

6.05

608

703

559

629

521

575

491

534

7.05

860

737

653

593

Source: MOSL

Stable Period

Beta

0.28

0.38

0.48

0.58

Sensitivity of volume growth to DCF (value/share)

(value/sh)

Sensitivity of realization growth to DCF (value/share)

(value/sh)

-1.5%

-1%

-0.5% Base case +0.5%

+1%

+1.5%

-1%

-1% Base case +1%

+1%

Source: MOSL

30 July 2012

Castrol India

Intrinsic P/E based valuation at INR631/share

Given its cash flow, growth and margin attributes, we have calculated the intrinsic

P/E multiple for Castrol. Relative valuation comparisons fail to adjust the variance in

cash flow (FCF), risk (beta), growth profile (reinvestment needs) and returns (RoE) in

different stocks. Intrinsic multiple calculations, however, incorporate the various

characteristics that determine the value of a firm.

Based on our intrinsic P/E calculation, Castrol should tarde at a P/E multiple of 27.8x

v/s the current 23.6x CY13E EPS. The intrinsic P/E of 27.8x implies a value of INR631/

share (based on CY13 estimates). Our expected RoE for Castrol in the growth period is

63%, while our expected RoE in the stable/terminal period is 40%.

Intrinsic P/E calculation for Castrol

Intrinsic PE Multiple

Current Inputs

Current Earnings (INR m)

Book value of equity (INR m)

Revenues (INR m)

Growth Period

Length of growth period (Years)

Growth rate during period (g)

Payout ratio during period (%)

Cost of Equity during period (%)

Stable/ Terminal Growth Period

Growth rate in steady state (%)

Payout ratio in steady state (%)

Cost of Equity in steady state (%)

Price/Earnings Ratio

Target Price (Based on CY13E EPS)

Current Price

% Upside

Cost of Equity: Growth Period

Rmp

Beta

COE

4,559

6,276

33,672

11.38%

11.01

6.05

10.84

27.8

631

536

ROE =

73%

Expected ROE =

63%

Expected ROE =

40%

8.1%

7.4%

0.40

11.0%

Cost of Equity: Stable Period

Rmp

Beta

COE

8.1%

7.4%

0.38

10.8%

Footnote:

The intrinsic P/E of a company can be stated as "Payout Ratio * (1 + Growth Rate) / (Cost of Equity - Growth Rate)". Here,

the growth rate (G) can be further divided into growth during high growth period and growth during stable/terminal period. P/

E for a stock is a derivative of the RoE a company makes in its current business (value in place), RoE it expects to make in its

future investments (value for growth) and the RoE we expect the company to make in its stable/terminal period. The reinvestment

in growth and stable period is calculated as (1- Payout Ratio).

30 July 2012

Castrol India

Comparative valuations

CMP

Asian Paints

Colgate

HUL

ITC

Nestle India*

Castrol India*

* CY year end

3,564

1,166

476

251

4,453

536

M Cap

(USD b)

6.0

2.8

17.9

35.5

7.6

2.3

EPS Gr. (%)

FY13 FY14

17.7 17.9

11.9 13.2

25.2 15.3

16.4 17.8

16.5 20.4

23.4 11.9

P/E

FY13

29.4

31.2

31.9

27.0

36.2

23.6

(x)

FY14

24.9

27.6

27.7

22.9

30.0

21.1

P/BV (x)

FY13 FY14

10.2

8.4

30.7 25.5

22.7 17.6

8.7

7.4

23.7 18.5

19.4 18.0

EV/EBIDTA

RoE (%)

RoCE (%) Pay. Ratio

FY13 FY14 FY13 FY14 FY13 FY14

FY12

17.7 13.9 34.7 33.8 46.6 45.6

38.8

22.5 19.3 108.1 101.0 108.5 101.3

78.0

25.1 21.6 71.2 63.7 93.3 83.8

63.0

17.5 14.7 32.3 32.2 45.4 45.7

52.7

23.3 18.7 77.0 69.1 64.9 66.5

53.3

15.6 13.9 74.0 85.6 99.1 116.7

89.9

Source: Bloomberg/MOSL

Castrol India: Historical P/E

Castrol India: Historical P/B

Castrol India: Historical EV/ sales

Castrol India: Historical EV/EBITDA

Source: Bloomberg/MOSL

30 July 2012

Castrol India

Key concerns

Longer oil drain intervals:

Over the last decade, volume growth in the lubricants

market has been low at 3-5%, despite strong growth in the automobile industry. This

has primarily been due to advances in technology, resulting in steadily increasing

drain intervals. Castrol enjoys superior pricing power and has been able to maintain

its margin/unit; it does not need to depend on volume growth.

Volatile raw material prices:

Most of Castrol's raw materials such as base oil and

additives are crude oil derivatives. As such, raw material price volatility is a key risk.

However, given low price sensitivity of lubricant demand and endogenous demand,

Castrol has historically been able to successfully deal with this challenge.

Aggressive foray by oil PSUs into bazzar trade:

The oil PSUs have begun attempting

aggressive forays into the bazzar trade and have begun giving tough competition to

private players. BPCL has enjoyed decent success with its 'MAK' brand. Increasing

advertisement spends by the oil PSUs could result in margin pressure for private

players like Castrol.

OEMs introducing own brands:

Some OEMs have introduced their own brands.

However, for these OEMs, lubricants are not a core business, and they do not have an

addressable market beyond their immediate requirements. Due to these issues, their

costs are relatively higher and they are also not able to achieve minimum efficiencies

of scale.

Exchange rate volatility:

Castrol imports ~40% of its raw material requirements, and

raw materials account for ~50% of its sales. As such, it is exposed to exchange rate

volatility. Nonetheless, Castrol has been able to pass on any adverse impact and

maintain fairly stable margins.

30 July 2012

Castrol India

Background

Castrol India Limited, a 71% subsidiary of BP, is a leading lubricants player in India,

with ~20% market share of the domestic automotive lubricants industry. It

manufactures and markets a range of automotive and industrial lubricants. It markets

its automotive lubricants under two brands - Castrol and BP. The company enjoys

leadership in most of the segments it operates in, including tractor oils, car engine

oils, two-wheeler 4-stroke oils, and multi-grade diesel engine oils.

Castrol has the largest manufacturing and marketing network amongst the lubricant

companies in India. It has five plants across the country, including a state-of-the-art

manufacturing facility at Silvassa. It has a distribution network of 270 distributors,

servicing over 70,000 retail outlets.

Though Castrol is present in both automotive lubricants and industrial lubricants, its

strengths are in the automotive segment. In CY11, the product mix between the

automotive and industrial & marine segments was ~86% and ~14%, respectively. EBIT

contribution was also similar, with the automotive segment contributing ~84% and

the industrial and marine segment contributing ~16%.

Castrol: Involvement across the value chain

Source: BP Downstream Presentation 2030

Castrol: Revenue and EBIT contribution from the automotive segment

Source: Company/MOSL

30 July 2012

Castrol India

Key management personnel

Mr SM Datta, Chairman

Mr SM Datta graduated with Honors in Chemistry from the Presidency College, Kolkata

and obtained a Post Graduate degree in Science & Technology from the University of

Calcutta. He is a Chartered Engineer, Fellow of the Institution of Engineers, Fellow of

the Indian Institute of Chemical Engineers, Member, Society of Chemical Industry

(London) and Honorary Fellow of All India Management Association. He has been

President of Associated Chambers of Commerce & Industry, President of the Council

of EU Chamber of Commerce in India, President of the Bombay Chamber of Commerce

& Industry, President of Indian Chemical Manufacturers Association, and Chairman of

Bombay First.

Mr R Kirpalani, Chief Operating Officer, Director - Automotive

Mr Ravi Kirpalani is an Economics (Honors) graduate from St Stephens College, Delhi

and an MBA from IIM, Kolkata. Mr Kirpalani has over 30 years of experience in Sales,

Marketing and Strategy. He joined Castrol India in 1999 as General Manager, East and

was promoted in 2002 to Vice President - Sales. In 2004, he was appointed as Customer

Director for India, Middle East, Turkey and Africa. In 2005, he moved to the UK as

Transformation Director and was a Member of the Global Strategy Team. He played a

key role in the implementation of the group's global strategy. Mr Kirpalani returned

to Castrol India in 2009 as Director - Automotive and Chief Operating Officer. Prior to

Castrol, Mr Kirpalani worked for Reckitt Benckiser for 12 years and for a leading

consumer products company in Muscat, Oman.

Mr Uday Khanna, Director

Mr Uday Khanna is a Chartered Accountant. Before joining Castrol, he was with the

Lafarge Group. He joined the Lafarge Group in Paris on 1 June 2003 as Senior Vice

President for Group Strategy, after a long experience of almost 30 years with Hindustan

Lever/Unilever in a variety of financial, commercial and general management roles

both nationally and internationally. From July 2005 to July 2011, Mr Khanna was the

Managing Director and Chief Executive Officer of Lafarge India.

Mr Sujit Vaidya, Director - Finance, Whole-time Director

Mr Sujit Vaidya has been Director - Finance and Whole-time Director since November

2010. Mr Vaidya served as an Additional Director at Castrol India from 12 October 2010

to 16 November 2010. He is a qualified Chartered Accountant with a varied experience

in financial control & accounting, business strategy & planning and financial analysis

of over 20 years in MNCs (P&G, Citibank), accounting & consulting firms (BCG & KPMG)

and a large oil company (BP/ Castrol).

30 July 2012

Castrol India

Financials and Valuation

Income Statement

Y/E December

Net Sales

Change (%)

Raw Material

Employee Cost

Other Manuf. Exp.

Selling Admin. & Other Exp.

Total Expenditure

EBITDA

Change (%)

% of Net Sales

Depreciation

EBIT

Interest & Finance Charges

Other Income

PBT

Tax

Effective Rate (%)

Reported PAT bef. MI

Change (%)

Adjusted PAT

Change (%)

CY10

28,020

17.2

13,847

993

6,492

4,446

20,770

7,249

26.0

25.9

243

7,006

395

7,377

2,474

33.5

4,903

28.7

4,914

27.6

CY11

30,821

10.0

16,945

1,111

6,492

4,650

24,239

6,582

-9.2

21.4

251

6,331

846

7,158

2,348

32.8

4,810

-1.9

4,853

-1.2

CY12E

32,865

6.6

18,820

1,183

6,492

4,831

26,458

6,407

-2.7

19.5

301

6,106

807

6,893

2,334

33.9

4,559

-5.2

4,559

-6.1

CY13E

35,353

7.6

19,166

1,273

6,492

5,179

27,364

7,989

24.7

22.6

331

7,657

848

8,485

2,873

33.9

5,612

23.1

5,612

23.1

(INR Million)

CY14E

38,579

9.1

20,711

1,350

6,493

5,671

29,637

8,942

11.9

23.2

362

8,580

940

9,500

3,217

33.9

6,283

12.0

6,283

12.0

Balance Sheet

Y/E December

Equity Capital

Reserves

Net Worth

Capital Employed

Gross Fixed Assets

Less: Depreciation

Net Fixed Assets

Curr. Assets

Inventory

Sundry Debtors

Cash & Bank Balances

Loans & Advances

Current Liab. & Prov.

Sundry Creditors

Provisions

Net Current Assets

Deferred Tax Liability

Application of Funds

E: MOSL Estimates

CY10

2,473

3,062

5,535

2,955

1,752

1,203

11,628

2,442

1,784

6,193

1,209

7,833

4,949

2,884

3,795

371

5,535

CY11

2,473

3,569

6,042

3,066

1,941

1,125

12,035

3,009

2,190

5,490

1,347

7,991

5,140

2,852

4,044

562

6,042

CY12E

2,473

3,803

6,276

3,676

2,242

1,434

13,064

3,334

2,333

5,950

1,446

8,784

5,834

2,950

4,280

562

6,276

(INR Million)

CY13E

2,473

4,370

6,843

4,026

2,573

1,452

14,169

3,388

2,510

6,716

1,556

9,341

5,750

3,592

4,828

562

6,843

CY14E

2,473

4,886

7,359

4,396

2,935

1,461

15,587

3,664

2,739

7,525

1,659

10,251

6,213

4,038

5,336

562

7,359

30 July 2012

Castrol India

Financials and Valuation

Ratios

Y/E December

Basic (INR)

Adj. EPS

Adj Cash EPS

Book Value per Share

DPS

Payout (Incl. Div. Tax) %

Valuation (x)

P/E

Cash P/E

EV/EBITDA

EV/Sales

Price to Book Value

Dividend Yield (%)

Profitability Ratios (%)

RoE

RoCE

Turnover Ratios

Debtors (Days)

Inventory (Days)

Creditors (Days)

Working Capital (Days)

Asset Turnover (x)

Gross Fixed Asset Turnover (x)

Leverage Ratio

Debt/Equity (x)

CY10

19.9

20.9

22.4

15.0

88.2

CY11

19.6

20.6

24.4

15.0

88.4

CY12E

18.4

19.7

25.4

15.0

94.9

CY13E

22.7

24.0

27.7

17.5

89.9

CY14E

25.4

26.9

29.8

20.0

91.8

27.0

25.7

17.4

4.5

23.9

2.8

27.3

26.0

19.3

4.1

21.9

2.8

29.1

27.3

19.8

3.9

21.1

2.8

23.6

22.3

15.8

3.6

19.4

3.3

21.1

19.9

14.0

3.2

18.0

3.7

79.4

112.6

93.7

133.6

83.8

109.4

74.0

99.1

85.6

116.7

129

-44

5.1

9.5

109

-28

5.1

10.1

110

-25

5.2

8.9

108

-23

5.2

8.8

108

-23

5.2

8.8

0.0

Cash Flow Statement

Y/E December

PBT before E.O. Items

Add : Depreciation

Add: Interest

Less : Direct taxes paid

Inc/Dec in WC

CF from operations

CF from Oper. incl. EO Items

(Inc)/Dec in FA

(Pur)/Sale of Investments

CF from investments

Inc/Dec in Networth

Inc/Dec in Debt

Less: Dividend Paid

CF from Fin. Activity

Inc/Dec of Cash

Add: Beginning Balance

Closing Balance

E: MOSL Estimates

CY10

7,377

243

2,474

364

5,535

(238)

(232)

4,325

(4,367)

935

5,258

6,193

CY11

7,158

251

2,348

(952)

4,129

(318)

4,311

(4,514)

(703)

6,193

5,490

CY12E

6,893

301

2,334

224

5,104

(300)

4,325

(4,344)

460

5,490

5,950

CY13E

8,485

331

2,873

218

6,181

(350)

5,046

(5,066)

765

5,950

6,716

CY14E

9,500

362

3,217

301

6,966

(370)

-370

5,767

(5,787)

810

6,716

7,525

30 July 2012

Castrol India

N O T E S

30 July 2012

Motilal Oswal Company Gallery

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