Castrol India - Initiating Coverage - Compelling Valuation & Counting on Dividend Support - Reliance Research

Key Triggers

- India is the world's 3rd largest lubricants market with ~ 2.7bn litre of annual consumption
- Castrol is No.1 private player with ~12% market share, while the OMCs enjoy ~45% market share
- Castrol's volume is expected to clock 2.5% CAGR over CY19-CY22E
- Premiumisation and power brands are expected to drive realization and margin
- Inexpensive valuation compared to FMCG players

Despite the impact of COVID-19 in the short-term, Castrol India (CSTRL) has maintained long-term volume growth guidance of 5-6% per year. We expect Castrol's volume to clock 2.5% CAGR over CY19-CY22E backed by: higher pent-up demand for vehicle repairing/servicing in 2HCY20, sustainable volume growth opportunity owing to RIL-BP JV, strategic alliances with auto majors, faster demand recovery in rural markets, digital technology and vast pan-India distribution network.

Average crude oil price of CY20 is most likely to be the lowest point of the decade. There is a strong (92%) correlation between crude oil prices and base oil prices from 1998 till CY20TD (in USD terms). Based on 1-year forward curve and Bloomberg estimate, the Brent prices are seen at US$42, US$45 and US$50 for CY20, CY21 and CY22, respectively. We expect CSTRL to get benefited from soft base oil prices and likely to post better gross margin, going forward. Its gross margin is expected to improve from 55% (CY19) to 58%, 59% and 59% in CY20, CY21 and CY22, respectively.

Castrol continues to remain at the helm of brand recall with its realization clocking 4% CAGR over last 3 years. We expect its blended realisation to keep on increasing, which would drive margin. Despite a blip in CY20, we expect Castrol's realization to recover, going forward on likely price revision in CY21, and touch the CY19-level in CY22E.

ESG Analysis: While analyzing 20 key criteria (10 points each) under ESG Matrix, we have assigned an overall score of 61% to CSTRL. Under "Environmental Head", we have assigned a 45% score, as the company is into the manufacturing of lubricants which pose a great danger to the environment. Under "Social Head", we have assigned 66% score, as the company has received many awards/accolades for its customer excellence, due representation of women in a managerial position and CSR spend. Under "Governance Head", we have assigned a 68% score, as it's a part of BP Group, which maintains a very high standard for corporate governance (please refer to page no 4. for detailed ESG analysis).

Outlook & Valuation

Castrol traded at an average 1-yr forward PE of 23x over CY17-20TD. At CMP, the stock trades at 10.6x CY22 EPS of Rs10.6 and EV/EBITDA of 6.6x (CY22) with EBITDA CAGR of 6% (CY19-22). Current dividend yield is ~5%. Due to lubricant players' similarity to FMCG companies in terms of financial metrics and consumer centric business, we have compared Castrol with FMCG peers and observed that it trades at 70% discount to FMCG players. The average RoE of FMCG proxy universe is ~50%, while PE multiple is 38x (consensus). Moreover, we have also calculated theoretical PE (dividend discount model), which is 15.6x for CY22E earnings. Hence, we are comfortable with our 16x target PE multiple for Castrol. Valuing the stock at 16x, we initiate coverage on CSTRL with a 2-Year Target Price of Rs.169, which implies 51% upside from the current level.

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Shares of CASTROL INDIA LTD. was last trading in BSE at Rs.111.55 as compared to the previous close of Rs. 111.55. The total number of shares traded during the day was 58106 in over 780 trades.

The stock hit an intraday high of Rs. 112.45 and intraday low of 111.1. The net turnover during the day was Rs. 6495406.

Source : Equity Bulls

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