Castrol India: Moving in the slow lane

Input cost pressure and lower volumes impact June quarter performance

Destocking because of the goods and services tax (GST) hit Castrol India’s performance in the June quarter (second quarter or Q2, as it follows January-December financial year). And, there was some lingering effect of demonetisation as well.

The impact was more profound on commercial vehicle oil volumes (40 per cent or more of the total volumes). Though the company still managed to register growth in the personal mobility segment, power brands and the industrial segment, it was not enough to prevent total revenues from operations declining 10 per cent over a year.

A ~6 per litre fall in realisations attributed to discounts the company gave, according to analysts to liquidate stocks, too, played spoilsport on profitability. This, coupled with lower revenue and volatility in base oil prices (a key input) led to a 33 per cent over a year and three per cent sequential decline in earnings before interest, tax, depreciation and amortisation (Ebitda) to ~209.5 crore. The Ebitda margins at 24.1 per cent came significantly lower than the 29.8 per cent it logged in the previous quarter and 32.5 per cent a year ago. Analysts at Motilal Oswal Securities had anticipated margins of 31.1 per cent. The base oil prices had increased in the March quarter but input costs pressure is felt with a lag of one quarter, and this impacted margins in the June quarter, say analysts. The per litre gross profit margins (the profit after accounting for raw material costs) fell from ~96 to ~86 sequentially, highlight analysts at HSBC. With operating performance under pressure, profit at ~138 crore was down 33 per cent over a year.

With a soft first half, the earnings estimates are bound to see some cuts. The company, however, is doing its bit to push up volumes and improve its market share and has renewed its distribution agreement with Essar Oil for the sale of Castrol lubricants through Essar’s retail network. It has also launched its new product, Castrol Hysol XBB, in the industrial lubricant segment. Further, with GST-led de-stocking behind, volumes should improve.

On margins, if costs remain stable, analysts believe profitability may improve, as the industry should take price hikes to some extent in the next two quarters. However, concerns of these price hikes, by Castrol especially, carry the risk of market share loss, say analysts at HSBC. The Street will, thus, be watching closely all these developments, including the trend in margins and volumes.

While Castrol’s superior balance sheet and cash flows are comforting, the stock is already trading at 25.8-27.8 times its 2018 earnings estimates, according to Motilal Oswal and HSBC. Thus, for significant upside to the stock trading at ~391 levels, profitability improvement and market share gains are crucial.