Initiating Coverage December 19, 2014

Rating Matrix India (CASIND) Rating : Buy Target : | 611 Target Period : 12-18 months | 508 Potential Upside : 20% Set to enjoy smooth ride....

Castrol India, a 71% subsidiary of British plc, is one of the YoY growth (%) leading players in the domestic lubricants business catering mainly to the (YoY Growth) CY13 CY14E CY15E CY16E automotive and industrial segments. The main focus of the company is Revenues 1.9 7.1 6.9 7.4 on the lucrative automotive lubricant segment where it commands a EBITDA 10.4 4.0 68.8 10.1 market share of ~22% in value terms. The company derives ~90% of its Net Profit 13.7 (5.6) 69.1 9.5 EPS 13.7 (5.6) 69.1 9.5 revenues from the automotive segment out of which passenger cars and two-wheelers contribute ~40% and ~35%, respectively, followed by the Valuation summary commercial vehicles segment, which contributes ~20% of revenues. CY13 CY14E CY15E CY16E Personal mobility (passenger cars and two wheelers) lubricant sales that P/E 49.4 52.3 30.9 28.3 had witnessed strong momentum over the past few years, will continue Target P/E 59.4 62.9 37.2 34.0 to remain the key growth driver for the company. The industrial segment, EV / EBITDA 35.7 34.5 20.2 18.2 which constitutes ~10% of revenues, is also expected to pick up with an P/BV 33.4 43.4 36.1 31.2 improvement in industrial activities. We expect Castrol to grow at a CAGR RoNW (%) 67.7 82.9 116.5 110.5 of 7.1% in revenues over CY13-16E on the back of strong growth in RoCE (%) 87.4 117.6 168.2 160.2 volumes and gross margins. Profit is expected to increase at 20.5% CAGR over CY13-16E to | 889.1 crore in CY16E. We initiate coverage on Castrol Stock Data India with a BUY rating. Bloomberg/Reuters Code CSTRL IN/ CAST NS Revival in Indian economy to fuel volume growth Sensex 27,371 Average volumes 388,278 Castrol’s volume had remained subdued over the past few years due to Market Cap (| crore) 25,123.6 the slowdown in the Indian economy. With the revival expected in the 52 week H/L 543/282 automobile sales and industrial growth, we believe Castrol’s volumes will Equity Capital (| crore) 247.3 increase at 3.8% CAGR over CY13-16E from 196.8 million litre in CY13 to Promoter's Stake (%) 71.0 220 million litre in CY16E. FII Holding (%) 8.2 DII Holding (%) 6.2 Sharp decline in crude oil prices to boost margins

With the sharp decline in crude oil prices over the past few months, raw Comparative return matrix (%) material costs (base oil prices) are expected to come down, aiding the Return % 1M 3M 6M 12M improvement in margins. The impact of lower base oil prices will be Castrol India 10.8 15.0 56.5 68.3 reflected in raw material costs from Q1CY15E. We expect Castrol’s Tide Water Oil 11.1 25.9 79.4 161.1 EBITDA to increase from | 34.9 per litre in CY13 to | 60.4 per litre in Gulf Oil Lubricant 41.8 73.9 - - CY16E on account of stable realisations and decline in raw material costs.

Bet on largest private player with strong pricing power Price movement Castrol’s strong brand positioning and superior distribution network 10,000 700 allows it to command higher pricing power and premium for its products 9,000 600 over its competitors. The company’s focus on the personal mobility 8,000 500 segment will remain the key driver for the automotive lubricant business 7,000 400 and will create value for shareholders, going forward. We value Castrol 6,000 300 India at 34x CY16E EPS of | 18 to arrive at a target price of | 611 with a 5,000 200 4,000 100 BUY rating. 3,000 0 Exhibit 1: Financial Performance Jul-14 Oct-13 Feb-13 Jan-12 Jun-13 Sep-12 Dec-14 Mar-14 (Year-end December) CY12 CY13 CY14E CY15E CY16E May-12 Price (R.H.S) Nifty (L.H.S) Revenues (| crore) 3,120.9 3,179.6 3,405.0 3,641.0 3,910.9 EBITDA (| crore) 622.8 687.6 714.9 1,207.1 1,328.6 Net Profit (| crore) 447.4 508.6 480.1 812.0 889.1 Research Analyst EPS (|) 9.0 10.3 9.7 16.4 18.0 Mayur Matani P/E (x) 56.2 49.4 52.3 30.9 28.3 Price / Book (x) 38.7 33.4 43.4 36.1 31.2 [email protected] EV/EBITDA (x) 39.4 35.7 34.5 20.2 18.2 Utkarsh Tathagath RoCE (%) 91.8 87.4 117.6 168.2 160.2 [email protected] RoE (%) 68.9 67.7 82.9 116.5 110.5

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research

Shareholding pattern (%) – Q3CY14 Company background

(in %) Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Castrol India, a 71% subsidiary of British Petroleum plc, is the largest Promoter 71.0 71.0 71.0 71.0 71.0 private sector lubricant player in India. The history of Castrol in India FII 9.2 9.0 8.3 8.2 8.2 dates back to 1910 when certain automotive lubricants from CC Wakefield DII 5.5 5.5 5.9 5.6 6.2 & Co made an entry into the Indian market. The company was founded as Others 14.3 14.5 14.8 15.2 14.6 an overseas branch of a British company and started operations as a trading unit. It was later renamed as Castrol in 1960. The company caters FII & DII holding trend (%) to the automotive, industrial and marine & energy segments. Castrol gets majority of its revenues from the automotive segment (~90%) out of 10.0 9.2 9.0 8.3 8.2 8.2 which the passenger cars and two-wheelers segments contribute ~40% 8.0 and ~35%, respectively, followed by the commercial vehicles segment 6.2 5.5 5.5 5.9 5.6 that contributes ~20% of revenues. The company commands a market 6.0 share of ~22% (value terms) in the automotive lubricant segment that has % 4.0 historically been dominated by PSU companies. Castrol operates three 2.0 manufacturing plants in India and has the largest distribution network of 380 distributors, servicing over 105,000 retail sites. The company has a - close association with OEM partners like , Jaguar Land Rover, BMW, Volkswagen, , etc. in the automotive segment.

Q3CY14 Q4CY14 Q1CY15 Q2CY15 Q3CY15 The industrial segment contributes ~10% of total revenues for Castrol. In FII DII the industrial segment, Castrol has its strength in OEM tie-ups and onsite service in the B2B segment.

The company mainly uses group 1 and group 2 base oils as its raw material. Castrol imports ~50% of its base oil requirements while the rest is procured from domestic oil companies. The royalty to British Petroleum is currently at 3.5% of sales subject to 10% (maximum) of profits. This is revised yearly and is expected to remain at this level in future. The company spends aggressively on advertising & marketing by way of tie- ups and sponsorships of cricket tournaments, car racing, etc. Castrol’s marketing initiative with sporting events and brand focused approach has also helped it to maintain its market share and remain among the top positions in the competitive lubricant market. The largest selling brand for the company is the “Activ” brand with a sale of ~32 million litre. Its other products like CRB plus, which is the largest selling diesel engine oil in the country, had volumes of 18 million litre. In the last 10 years, revenues and profits have grown at a CAGR of 10.2% and 14%, respectively. However, due to adverse economic conditions and slowdown in volumes, revenues and profits in the last two years have recorded growth at a CAGR of 3% and 2.8%, respectively.

Exhibit 2: Overview of Castrol’s business in CY13

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 2

Overview of Indian lubricant sector The domestic lubricant industry is a US$4.8-5.1 billion market with volumes of ~2350 million litre growing at a CAGR of 2-3% in the past few years. The lubricants industry comprises automotive, industrial and process oils segments with volumes of ~1100 million litre, ~550 million litre and ~700 million litre, respectively. Listed Indian lubricant players mainly cater to the automotive and industrial lubricants segments. The automotive lubricants segment, currently comprising oil PSUs, multinational companies and a number of small and regional players, is highly fragmented.

Historically, pre-liberalisation, the lubricants market was dominated by PSU oil companies that controlled more than 90% of the market. There were restrictions on import of base oil in India and lower trade margins that led to poor availability and service to customers. Post liberalisation, base oil imports were de-canalised and the administered pricing mechanism was gradually scrapped. A reduction of import duty and allowing the PSU oil majors to form JVs led to the entry of all major global oil companies in India. The entry of many players in the market led to a shift in the lube business from petrol pumps to the Bazaar trade. Increased spends & brand building efforts to gain market share increased the competitive activities in the market. Due to this situation, PSU oil companies lost ground and gave way to private companies.

Exhibit 3: Overview of Indian lubricant market (FY14)

Currently, multinational and oil PSUs dominate the automotive lubricants business in India. Within the automotive segment, original equipment manufacturers (OEMs) have a market share of ~10% (115 million litre) while the replacement segment commands a market share of ~90% (985 million litre).

Source: Industry, ICICIdirect.com Research

Currently, multinational and oil PSUs dominate the automotive lubricants business in India. Within the automotive segment, original equipment manufacturers (OEMs) have a market share of ~10% (115 million litre) while the replacement segment commands a market share of ~90% (985 million litre). Petrol pumps now constitute only ~17% (170 million litre) while bazaar trade (retailers, mechanics, workshops & spare part dealers) constitute ~83% (815 million litre) of the total replacement market. The bazaar trade segment, which had stable growth, continues to remain the key driver for lubricant players. Oil PSUs, which used to command ~90% of the market pre-liberalisation, now only contribute ~30% to the bazaar trade segment. Multinational companies like Castrol, Total, Shell, etc, through their strong brands and differentiated marketing, have more than 30% market share of the bazaar trade segment. Other private sector players are currently investing aggressively in advertising & marketing and aiming to gain market share through competitive pricing.

ICICI Securities Ltd | Retail Equity Research Page 3

Exhibit 4: Market share of lubricant companies in bazaar trade segment (FY14)

4% 7% 22% 7%

6% Multinational companies like Castrol, Total, Shell, etc, through their strong brands and differentiated marketing, 5% have more than 30% market share of the bazaar trade segment. 28% 21% Castrol PSU's others Shell Total Gulf Oil Lubricants Veedol Valvoline

Source: Industry, ICICIdirect.com Research

Exhibit 5: Product portfolio of Indian lubricant companies Major Products Company Name Brand Name Two wheelers Petrol vehicles Diesel vehicles Corporation Ltd MAK MAK 2T, Mak 4T Plus SL MAK Elite MAK multigrade, MAK gold plus Corporation Ltd HP HP Racer, Super Brake Fluid Hp Extra Super Motor oil, Hp Cruise Hp Laal Ghoda, Milcy Ltd SERVO Servo-2T, Servo-4T Servo-Pride tc Super multigrade, Servo-Xtrapremium, Pride 40 Castrol India Ltd. Castrol Castrol Activ, Castrol Go GTX Petrol, Castrol Edge GTX Diesel, CRB Plus, CRB Turbo Gulf Oil Corporation Ltd Superfleet Gulf Pride 2T, Gulf Pride 4T Gulf Super Fleet 15w-40 Gulf XHD Plus, Superfleet LE Max Tide Water Oil Corporation Ltd Veedol Super Swift, Take-off Blue Blood, Turbostar Max-Pro, Turbo, HDB, Deep Sea Source: Industry, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 4

Investment Rationale Revival in Indian economy to fuel volume growth Castrol’s volume had remained subdued over the past few years due to the slowdown in automobile sales and industrial growth. With the revival Total sales volume of Castrol India is expected to increase expected in the Indian economy, we believe Castrol’s volume will from 196.8 million litres in CY13 to 220 million litres in increase at 3.8% CAGR over CY13-16E from 196.8 million litre in CY13 to CY16E 220 million litre in CY16E.

Exhibit 6: Castrol lubricant sales volume Exhibit 7: Castrol lubricant sales growth

230 8 220.0 219.0 220.0 7.1 5.6 5.6 220 214.6 6 208.4 4 210 207.7 204.5 203.9

% 2 197.4 0.3

million litres 196.8 200 0

-2 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E 190 -1.8 -3.5 -4 -2.6 -2.5 -4.7 180 -5.2 -6 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E

Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research

Improvement in auto sales; most important factor behind the volume growth The prospects of the lubricant industry are highly dependent on growth in the automotive sector. We expect the automobile sector to post sales growth at 13.2% CAGR over FY14-17E to 314 lakh units in FY17E on the back of an improvement in the macroeconomic scenario in the country.

Exhibit 8: Indian automobile sales volume and growth trend

360 30 314.0 300 274.8 25 243.7 216.5 New auto sale is expected to increase from 216.5 lakh 240 204.4 206.6 20 180.8 units in FY14 to 314 lakh units in FY17E with a growth of 180 15 13.2% CAGR YoY 143.9 111.3 109.9 113.3 %

lakh units 120 10

60 5

0 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E -60 -5

Source: SIAM, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 5

Commercial vehicles sales, the largest contributor to the lubricant industry sales volume, had remained subdued in the past few years. CV sales are now expected to increase at 12.4% CAGR over FY14-17E to 8.8 lakh units in FY17E.

Exhibit 9: Indian commercial vehicle sales volume Exhibit 10: Indian commercial vehicle sales growth

10 50 8.8 8.0 7.8 40 8 7.3 6.8 30 6.2 6.3 6 5.3 20 4.6 4.9 % 3.8 10 4

lakh units 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E 2 -10 -20 0 -30 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15EFY16EFY17E

Source: SIAM, ICICIdirect.com Research Source: SIAM, ICICIdirect.com Research

Passenger vehicles, two wheelers and four wheelers, which contribute more than 50% of Castrol’s sales volume, are expected to witness a recovery on account of the improved economic sentiments and pent-up demand due to subdued sales over the past few years. We expect two- wheelers and four-wheelers sales to increase at 13.7% and 11.3% CAGR, respectively, over FY14-17E to 220.5 lakh units for two wheelers and 35.5 lakh units for four wheelers in FY17E.

Exhibit 11: Indian passenger vehicles and two-wheeler volume and growth trend

250 220.5 50 193.5 200 175.1 40 150.2 136.5 138.4 150 119.1 30 Passenger vehicles and 2-wheeler sales are expected to 94.2 increase from 25.8 and 150.2 lakh units in FY14 to 35.5 100 74.5 71.7 74.9 20 % 30.9 35.5 and 220.5 lakh units in FY17E, respectively lakh units 25.8 50 25.0 26.5 27.0 27.6 10 13.4 15.1 16.0 20.6 0 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E -50 -10

Passenger Vehicles (PV) 2-Wheelers (2W) PV Growth 2W Growth

Source: SIAM, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 6

Hence, on the back of an improvement in automotive demand, we expect Castrol’s automotive sales to improve at 3.5% CAGR over CY13-16E from 169.3 million litre in CY13 to 187.9 million litre in CY16E.

Exhibit 12: Castrol auto sales volumes and growth trend

300 269.0 24 244.2 250 222.5 20 202.9 187.9 200 181.4 175.6 169.3 168.8 178.1 16 150 12 We expect Castrol’s automotive sales to improve at 3.5%

100 8 % CAGR over CY13-16E from 169.3 million litre in CY13 to 24.4 27.5 31.4 million units million 50 20.7 21.7 4 187.9 million litre in CY16E 0 0 -50 CY12 CY13 CY14E CY15E CY16E -4 -100 -8 Vehicle Sales Registered Vehicles (E) Auto lubricants sales volume Auto lubricants sales Growth Vehicle Sales Growth

Source: SIAM, ICICIdirect.com Research

Industry growth pick up will contribute to higher industrial sales volume The demand for lubricants in the industrial sector is primarily driven by industrial production. The last few years have been challenging for Castrol in industrial sales due to subdued economic activity triggered by sustained inflation, higher raw material prices and lower demand for consumer goods & capital goods. Castrol’s lubricant sales volumes were also impacted due to aggressive pricing by PSU oil companies and other regional players.

Exhibit 13: IIP and industrial lubricants growth

18

10.4 12 8.3

6 5.5 1.2 Castrol’s lubricant sales volumes were impacted in period 5.3 -0.1 0 3.1 CY09-13 due to aggressive pricing by PSU oil companies % FY10/CY09 FY11/CY10 FY12/CY11 FY13/CY12 FY14/CY13 and other regional players -6 -2.9 -14.1 -12 -11.3

-18 IIP Growth Castrol's Industrial lubricants volume Growth

Source: Bloomberg, Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 7

However, manufacturing activity is expected to gain momentum in the next few years due to the strong focus of the new government on Castrol’s industrial sales are expected to improve at 5.3% manufacturing and the industrial sector along with increasing domestic CAGR over CY13-16E from 27.5 million litre in CY13 to 32.1 demand on the back of an improvement in consumer sentiment. We million litre in CY16E expect Castrol’s industrial sales to improve at 5.3% CAGR over CY13-16E from 27.5 million litre in CY13 to 32.1 million litre in CY16E.

Exhibit 14: Industrial lubricants volume trend Exhibit 15: Industrial lubricants volume growth trend

45 43.8 12 10.4 3.9 6.0 6.0 6 40 5.5 0 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E

35 % -6 31.9 31.9 32.1 -2.8 million litres million -12 30.3 -14.1 28.9 -11.3 30 28.3 28.6 -18 27.4 27.5 -15.3 -24 25 -30 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E -27.1

Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research

Sharp decline in crude oil prices to boost margins With the sharp decline in crude oil prices over the past few months, raw materials costs (base oil prices) for Castrol are expected to come down, aiding the improvement in margins. We expect EBITDA margins to improve from 21.6% in CY13 to 34% in CY16E on account of stable realisations and a decline in raw material costs.

Exhibit 16: Crude oil and base oil price trend

1500

1200

The sharp decline in crude oil prices over the past few 900 months, are expected to bring down raw materials costs, 600 aiding the improvement in margins US$ per tonne per US$ 300

0 Q1CY05 Q3CY05 Q1CY06 Q3CY06 Q1CY07 Q3CY07 Q1CY08 Q3CY08 Q1CY09 Q3CY09 Q1CY10 Q3CY10 Q1CY11 Q3CY11 Q1CY12 Q3CY12 Q1CY13 Q3CY13 Q1CY14 Q3CY14

Brent Crude Oil Prices Base oil prices

Source: Bloomberg, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 8

We believe Castrol, which is the price maker in the Indian automotive lubricant market, will maintain stable realisations, going forward. Castrol would continue to command a pricing premium to other private players. We expect its automotive realisation at | 186.3/litre in CY16E, in spite of a decline in base oil prices. With respect to the industrial lubricant market, we expect Castrol to pass on the benefits of the lower base oil prices to the consumers.

Exhibit 17: Automotive and non-automotive realisation trend

210 182.6 186.3 190 176.4 164.9 170 154.7 We believe Castrol will maintain stable realisations in the 150 145.3 automotive segment, while benefits of the lower base oil 124.4 141.1 149.2 prices will be passed on to the customers in the industrial 130 141.6 113.4 128.0 135.0

| per litre 128.4 127.9 lubricant segment 110 103.2 90.4 113.1 85.1 90 100.4

70 68.1 50 52.3 CY06 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E

Automotive Realisations Non-Automotive Realisations

Source: Company, ICICIdirect.com Research

Hence, on a blended basis, the net realisation is expected to increase from | 161.6 per litre in CY13 to | 177.7 per litre in CY16E whereas the raw material costs is expected to decline from | 90.9 per litre in CY13 to | 77.9 per litre in CY16E. The impact of lower base oil prices will be reflected in the raw material costs from Q1CY15E and will result in higher gross margins as witnessed in CY09. We expect gross margins to increase by | 29.1 litre over CY13-16E from | 70.7 per litre in CY13 to | 99.8 per litre in CY16E. Subsequently, we expect the EBITDA to increase from | 34.9 per litre in CY13 to | 60.4 per litre in CY16E.

Exhibit 18: Net realisation, raw material cost and gross margin trends

200

160 The impact of lower base oil prices will be reflected in the raw material costs from Q1CY15E. We expect gross 120 margins to increase from | 70.7 per litre in CY13 to 96.3 99.8

| per litre 80 | 99.8 per litre in CY16E. 70.7 74.0 58.4 61.6 62.1 63.4 50.8 56.7 40 38.7

0 CY06 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E CY16E

Net Realisation Raw Material Costs Gross Margins

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 9

Exhibit 19: Expected change in EBITDA per litre

75

60 13.0 1.6 2.1 45 16.2

| per litre 30 60.4

15 34.9

0 EBITDA Increase in Decrease in Increase in Increase in EBITDA (CY13) Revenues raw material employee other (CY16E) costs costs expenditure

Source: ICICIdirect.com Research

Castrol largest private player with strong pricing power Castrol’s strong brand positioning and superior distribution network allows it to command higher pricing power and a premium for its products over its competitors. The company’s focus on the personal mobility segment (passenger cars and two wheelers) through the bazaar trade market has aided it to maintain its market share and automotive lubricant volumes. This resulted in 7.8% CAGR over CY13-16E in automotive revenue from | 2791.6 crore in CY13 to | 3500.1 crore in CY16E despite a weak economic environment. Also, Castrol’s ability to leverage its tie-up with OEMs like Maruti, Volkswagen, etc. and industrial customers like L&T Komatsu, Volvo, etc. has contributed to the revenues.

Exhibit 20: Strong pricing power of Castrol

Sharp increase in gross margins due to decline in raw material costs and stable 165 realisations 70

140 61.8 66 We believe Castrol’s will benefit from its strong pricing 63.7 63.4 power as witnessed in CY09 though sharp improvement in 60.4 115 60.7 62 the gross margins 58.4 57.7

| per litre | per 90 58 | per litre | per

65 54 51.4

40 50 Q1CY09 Q2CY09 Q3CY09 Q4CY09 Q1CY10 Q2CY10 Q3CY10 Q4CY10 Gross Margins (RHS) Realisations (LHS) Raw material costs (LHS)

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 10

Castrol spends 6.5-7.5% of total revenues on advertising & marketing enabling it to position its products similar to FMCG companies. Continuous innovations through products (multi-grade engine oil, gearless scooter oil, two-stroke motor cycle oil, etc) and differentiated market routes (creation of bazaar trade, bike point, pit stop, etc.) have been the key strengths of the company behind its volumes and premium pricing. The company’s next push is focused on the rural market, which is growing at 10% YoY. Castrol plans to increase its number of rural dealers to increase its market share in the two-wheeler segment. In urban areas, Castrol has a 40% market share in the top 10 cities, which is mainly driven by passenger cars.

Exhibit 21: Overview of Castrol’s business strengths and strategy

Source: Company, ICICIdirect.com Research

Exhibit 22: Castrol’s strategy and strengths

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 11

Financials Stable growth in revenues mainly due to automotive lubricant business We expect revenues to increase from | 3179.6 crore in CY13 to | 3910.9 crore in CY16E at 7.1% CAGR over CY13-16E mainly on account of the automotive lubricant business. Revenues from automotive lubricants in the same period of CY13-16E are expected to increase at 7.8% CAGR from | 2791.6 crore in CY13 to | 3500.1 crore in CY16E due to higher volumes (3.5% CAGR) and realisations (4.1% CAGR). The non-automotive lubricant business is expected to grow at 1.9% CAGR from | 388 crore in CY13 to | 410.8 crore in CY16E due to 5.3% CAGR in volumes.

Exhibit 23: Trend in revenues 3910.9 3641.0 4000 3405.0 3179.6 410.8 3117.8 388.9 426.6 3000 400.6 388.0

Total revenues are expected to increase from | 3179.6 2000

| crore 3500.1 crore in CY13 to | 3910.9 crore in CY16E mainly on 3252.1 2717.2 2791.6 2978.4 account of automotive lubricant revenues 1000

0 CY12 CY13 CY14E CY15E CY16E

Automotive Revenue Non-Automotive Revenue

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 12

Higher gross margins to drive EBITDA growth The EBITDA of Castrol had marginally declined from | 733.2 crore in CY10 to | 687.6 crore in CY13 on the back of 10.1% decline in volumes from 219 million litre to 196.8 million litre. However, the gross margins per litre continued to remain strong during the same period. With the revival now expected in Indian automobile sales & industrial growth and due to the decline in crude oil prices, we expect gross margins per litre to increase from | 70.7 per litre in CY13 to | 99.8 per litre in CY16E (at 12.2% CAGR over CY13-16E) and volumes to increase from 196.8 million litre in CY13 to 220 million litre in CY16E at 3.8% CAGR over CY13-16E. Subsequently, the EBITDA is expected to increase from | 687.6 crore in CY13 to | 1328.6 crore in CY16E at 24.6% CAGR over CY13-16E. The EBITDA margin during the same period is expected to increase 1240 from 21.6% in CY13 to 34% in CY16E.

Exhibit 24: EBITDA and EBITDA margins trend

34.0 1500 33.2 35

1200 30

EBITDA is expected to increase from | 687.6 crore in CY13 900 25 % 21.6 to | 1328.6 crore in CY16E with margins improving from | crore 21.0 1328.6 20.0 1207.1 21.6% in CY13 to 34% in CY16E 600 20 714.9 622.8 687.6 300 15 CY12 CY13 CY14E CY15E CY16E

EBITDA EBITDA Margins

Source: Company, ICICIdirect.com Research

Exhibit 25: Trends in operational revenue break-up

100.0 20.0 21.6 21.0 80.0 33.2 34.0 17.5 17.5 17.2 60.0 4.1 4.6 4.7 17.1 17.1

% 4.9 5.1 40.0 Lower raw material costs as a percentage of revenues will 58.5 56.2 57.1 drive EBITDA margins 20.0 44.9 43.8

0.0 CY12 CY13 CY14E CY15E CY16E

Raw Material Cost Employees Cost Other Expenditure EBITDA

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 13

Net profit to increase at 20.5% CAGR over CY13-16E We expect PAT to grow at a CAGR of 20.5% over CY13-16E on the back of an 11.8% improvement in sales volumes and 41.1% increase in gross margins per litre during the same period. The PAT is expected to grow from | 508.6 crore in CY13 to | 889.1 crore in CY16E.

Exhibit 26: PAT trend

1000

800

600

The PAT is expected to grow from | 508.6 crore in CY13 to

| crore 889.1 400 812.0 | 889.1 crore in CY16E at a CAGR of 20.5% over CY13-16E 508.6 480.1 200 447.4

0 CY12 CY13 CY14E CY15E CY16E

Source: Company, ICICIdirect.com Research

With increasing profitability, we expect the company’s return ratios to improve, going forward. We expect the RoE to improve from 67.7% in CY13 to 110.5% in CY16E. The RoCE is also expected to improve from 87.4% in CY13 to 160.2% in CY16E. We expect the dividend to increase from | 7 per share in CY13 to | 13.5 per share in CY16E, with a dividend payout ratio of ~75%.

Exhibit 27: RoE and RoCE trend

200 168.2 160.2 160 117.6 120 91.8 Castrol’s ROE and ROCE is expected to increase from 87.4 % 116.5 110.5 67.7% and 87.4% in CY13 to 110.5% and 160.2% in CY16E, 80 respectively 82.9 40 68.9 67.7

- CY12 CY13 CY14E CY15E CY16E

ROE ROCE

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 14

Exhibit 28: Dividend and payout ratio trend

15 13.5 100 12.0 77.4 72.1 73.1 75.1 12 68.1 80

9 60 We expect the dividend to increase from | 7 per share in 7.0 7.0 7.0 CY13 to | 13.5 per share in CY16E, with a dividend payout % 6 40

ratio of ~75%. share| per

3 20

- 0 CY12 CY13 CY14E CY15E CY16E

DPS Payout Ratio

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 15

Risks & concerns Volatility in crude oil prices & exchange rate Majority of Castrol’s raw material costs like base oil and additives are crude oil derivatives. Sharp volatility in crude oil prices along with foreign exchange volatility (~50% of raw materials are imported) may impact the margin outlook of the company and are key risks to the business. Any increase in crude oil prices from our estimates and depreciation in the rupee may impact the profitability of the company, going forward.

Exhibit 29: Sensitivity of EPS to change in crude oil prices CY15E CY16E Crude Oil Prices US$ 55/bbl US$ 75/bbl (Base Case) US$ 95/bbl US$ 55/bbl US$ 75/bbl (Base Case) US$ 95/bbl EPS (|) 19.4 16.4 12.0 22.2 18.0 13.2

Source: ICICIdirect.com Research

Exhibit 30: Sensitivity of EPS to change in exchange rate

CY15E CY16E Exchange Rate | 55/ US$ | 61/ US$ (Base Case) | 65/ US$ | 55/ US$ | 61/ US$ (Base Case) | 65/ US$ EPS (|) 17.9 16.4 15.5 19.5 18.0 17.0

Source: ICICIdirect.com Research

Improvement in technology may impact volume growth Investments by OEMs and lubricant players for the improvement in technology are expected to lead to higher drain intervals in future, which may impact the volume growth outlook of the company. For example, engine oils in trucks are able to maintain their physicochemical and performance properties for a longer period of usage than earlier generation lubricants, thus lengthening oil drain intervals from ~10000 km to ~40000 km. This may have an impact on structural demand in the industry. Increased competition from small private players, oil PSUs Castrol, one of the leading players in the automotive lubricant markets, has been facing stiff competition from small private players and oil PSUs due to aggressive pricing and higher sales promotion to gain market share. Although Castrol has maintained its market share, its ability to charge a higher premium above a certain threshold has reduced. For example, Castrol’s market share in the automotive segment reduced by 100-200 bps while volumes declined 7.5% YoY in 2011, when it took a sharp price hike, which was not followed by its competitors. Any reduction in lubricant prices by its competitors may force Castrol to reduce prices as well and may impact our profitability estimates. Exhibit 31: Sensitivity of EPS to change in realisations CY15E CY16E Blended Price | 150/ litre | 174.7/ litre (Base Case) | 200/ litre | 150/ litre | 177.7/ litre (Base Case) | 200/ litre EPS (|) 10.7 16.4 22.3 11.2 18.0 23.4

Source: ICICIdirect.com Research

Slowdown in auto sales and industrial activities Castrol’s future prospects rely heavily on growth in automotive sales, which witnessed a slowdown in the last few years. With the revival expected in the economy, we have estimated 13.2% CAGR in auto sales over CY13-16E. However, if the slowdown in the economy continues in future, it may impact Castrol’s automotive lubricant as well as industrial lubricant sales.

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Valuation We expect an improved performance from Castrol over the next two years on account of a sharp decline in crude oil prices and a revival in automobile sales and industrial growth. The decline in raw material costs and strong pricing power of Castrol are expected to lead to an improvement in gross margins. Castrol’s strong brand positioning and superior distribution network will allow it to command higher pricing power and premium for its products over its competitors. Also, the company’s focus on the personal mobility segment will remain the key driver for the automotive lubricant business and create value for shareholders, going forward. We expect revenues and profits to grow at a CAGR of 7.1% and 20.5% over CY13-16E to | 3910.9 crore and | 889.1 crore, respectively. We value Castrol India at 34x CY16E EPS of | 18 to arrive at a target price of | 611 with a BUY recommendation.

Exhibit 32: P/E multiple trend 600

500

400 (|) 300

200

100 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

Price 32x 30x 28x 26x 24x 21x 19x

Source: Reuters, ICICIdirect.com Research

We have compared Castrol’s valuation with FMCG companies on account of its strong brand position, aggressive advertising spends and high pricing power, which is similar to FMCG companies. Also, the company’s financials are comparable to FMCG companies, which deliver superior return ratios (Castrol RoE - 110.5% and RoCE- 160.2% in CY16E). Hence, we have valued Castrol at 34x CY16E EPS of | 18 to arrive at a target price of | 611.

Exhibit 33: Peer valuation CMP M Cap EPS (|) P/E (x) RoE (%) Sector / Company (|) (| Cr) CY14E CY15E CY16E CY14E CY15E CY16E CY14E CY15E CY16E Colgate (COLPAL) 1,759 23,921 41.3 47.9 54.8 42.6 36.7 32.1 78.8 74.5 71.1 (HINLEV) 764 165,355 19.4 21.3 23.9 39.4 35.9 32.0 109.6 104.4 102.2 Nestle (NESIND) 6,100 59,000 120.7 137.2 153.1 50.5 44.5 39.8 44.9 49.3 52.3 Procter & Gamble (PROGAM) 5,770 18,732 106.2 126.0 148.7 54.3 45.8 38.8 30.6 30.2 34.4 Glaxo Consumer (SMIBC) 5,633 23,690 142.5 166.1 198.0 39.5 33.9 28.4 30.9 30.0 30.5 Average 45.3 39.4 34.2 58.9 57.7 58.1 Castrol India (CASIND) 508 25,124 9.7 16.4 18.0 52.3 30.9 28.3 82.9 116.5 110.5

Source: ICICIdirect.com Research

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Financial Summary Exhibit 34: Profit and Loss Statement (| crore) (Year-end December) CY12 CY13 CY14E CY15E CY16E Revenue 3120.9 3179.6 3405.0 3641.0 3910.9 Growth (%) 4.3 1.9 7.1 6.9 7.4 (Inc.)/(Dec.) in stock in trade -17.3 -31.4 -4.5 0.0 0.0 Raw material Costs 1694.8 1681.4 1782.8 1494.6 1570.6 Purchase of Products 146.8 138.5 165.7 138.8 143.7 Employee Costs 128.4 146.0 158.8 177.9 199.2 Other Expenditure 545.4 557.5 587.3 622.6 668.8 Op. Expenditure 2,498.1 2,492.0 2,690.1 2,433.9 2,582.3 EBITDA 622.8 687.6 714.9 1207.1 1328.6 Growth (%) -7.0 10.4 4.0 68.8 10.1 Depreciation 26.6 30.5 33.6 35.0 39.4 EBIT 596.2 657.1 681.3 1172.1 1289.2 Interest 2.1 1.7 2.2 1.8 2.0 Other Income 72.2 106.4 49.3 60.0 60.0 PBT 666.3 761.8 728.4 1230.3 1347.2 Growth (%) -6.9 14.3 -4.4 68.9 9.5 Tax 218.9 253.2 248.4 418.3 458.0 Reported PAT 447.4 508.6 480.1 812.0 889.1 Growth (%) -7.0 13.7 -5.6 69.1 9.5 EPS 9.0 10.3 9.7 16.4 18.0

Source: Company, ICICIdirect.com Research

Exhibit 35: Balance Sheet (| crore)

(Year-end December) CY12 CY13 CY14E CY15E CY16E Source of Funds Equity Capital 494.6 494.6 247.3 247.3 247.3 Preference capital 0.0 0.0 0.0 0.0 0.0 Reserves & Surplus 154.7 256.9 331.9 449.5 557.5 Shareholder's Fund 649.2 751.4 579.2 696.8 804.8 Loan Funds 0.0 0.0 0.0 0.0 0.0 Deferred Tax Liability -65.9 -53.0 -53.0 -53.0 -53.0 Minority Interest 0.0 0.0 0.0 0.0 0.0 Source of Funds 583.3 698.5 526.2 643.8 751.8

Application of Funds Gross Block 202.6 193.1 226.8 261.8 301.2 Less: Acc. Depreciation 126.1 143.5 124.8 104.8 80.4 Net Block 31.0 31.9 31.9 31.9 31.9 Capital WIP 157.1 175.3 156.7 136.7 112.3 Total Fixed Assets 188.0 207.2 188.6 168.6 144.1 Investments 0.0 0.0 0.0 0.0 0.0 Inventories 315.8 374.0 401.1 428.9 460.7 Debtor 219.6 237.2 251.9 269.3 289.3 Cash 573.8 594.2 435.0 746.0 918.6 Loan & Advance, Other CA 147.4 181.3 191.3 201.3 211.3 Total Current assets 1256.6 1386.7 1279.2 1645.5 1879.9 Current Liabilities 563.5 604.6 648.4 693.3 744.7 Provisions 266.8 259.0 261.4 445.1 495.7 Total CL and Provisions 830.3 863.6 909.7 1138.4 1240.4 Net Working Capital 426.2 523.1 369.5 507.2 639.6 Miscellaneous expense 0.0 0.0 0.0 0.0 0.0 Application of Funds 583.3 698.5 526.2 643.8 751.8

Source: Company, ICICIdirect.com Research

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Exhibit 36: Cash Flow Statement (| crore) (Year-end December) CY12 CY13 CY14E CY15E CY16E Profit after Tax 447.4 508.6 480.1 812.0 889.1 Less: Dividend Paid 402.4 405.0 405.0 694.4 781.2 Add: Depreciation 26.6 30.5 33.6 35.0 39.4 Add: Others 0.0 0.0 0.0 0.0 0.0 Cash Profit 62.0 147.0 108.6 152.6 147.4 Increase/(Decrease) in CL 31.2 33.3 46.1 228.6 102.0 (Increase)/Decrease in CA -28.3 -109.7 -51.8 -55.3 -61.8 CF from Operating Activities 64.9 70.6 103.0 326.0 187.6 Purchase of Fixed Assets 40.1 48.7 15.0 15.0 15.0 (Inc)/Dec in Investments 0.0 0.0 0.0 0.0 0.0 Others 0.0 0.0 1.0 2.0 3.0 CF from Investing Activities -40.1 -48.7 -15.0 -15.0 -15.0 Inc/(Dec) in Loan Funds 0.0 0.0 0.0 0.0 0.0 Inc/(Dec) in Sh. Cap. & Res. 0.0 -1.3 -247.3 0.0 0.0 Others 0.0 0.0 1.0 2.0 3.0 CF from financing activities 0.0 -1.3 -247.3 0.0 0.0 Change in cash Eq. 24.8 20.5 -159.2 311.0 172.6 Op. Cash and cash Eq. 549.0 573.8 594.2 435.0 746.0 Cl. Cash and cash Eq. 573.8 594.2 435.0 746.0 918.6

Source: Company, ICICIdirect.com Research

Exhibit 37: Ratio Analysis

(Year-end December) CY12 CY13 CY14E CY15E CY16E Per share data (|) Book Value 13.1 15.2 11.7 14.1 16.3 Cash per share 11.6 12.0 8.8 15.1 18.6 EPS 9.0 10.3 9.7 16.4 18.0 Cash EPS 9.6 10.9 10.4 17.1 18.8 DPS 7.0 7.0 7.0 12.0 13.5 Profitability & Operating Ratios EBITDA Margin (%) 20.0 21.6 21.0 33.2 34.0 PAT Margin (%) 14.3 16.0 14.1 22.3 22.7 Fixed Asset Turnover (x) 19.9 18.1 21.7 26.6 34.8 Inventory Turnover (Days) 36.9 42.9 43.0 43.0 43.0 Debtor (Days) 25.7 27.2 27.0 27.0 27.0 Current Liabilities (Days) 65.9 69.4 69.5 69.5 69.5 Return Ratios (%) RoE 68.9 67.7 82.9 116.5 110.5 RoCE 91.8 87.4 117.6 168.2 160.2 RoIC 790.2 418.0 472.5 NA NA Valuation Ratios (x) PE 56.2 49.4 52.3 30.9 28.3 Price to Book Value 38.7 33.4 43.4 36.1 31.2 EV/EBITDA 39.4 35.7 34.5 20.2 18.2 EV/Sales 7.9 7.7 7.3 6.7 6.2 Leverage & Solvency Ratios Debt to equity (x) 0.0 0.0 0.0 0.0 0.0 Interest Coverage (x) 283.9 386.5 309.7 651.2 644.6 Debt to EBITDA (x) 0.0 0.0 0.0 0.0 0.0 Current Ratio 1.5 1.6 1.4 1.4 1.5 Quick ratio 1.1 1.2 1.0 1.1 1.1

Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 19

Annexure Overview of BP-Castrol’s global lubricant operations Castrol’s global lubricants business is focused on quality premium lubricants and high growth markets, with competitive advantage driven by leading brands, advantaged formulation technology and distinctive partner and customer relationships. The Lubricants business has become a material part of Downstream with pre-tax profits of nearly $1.3bn in 2013 representing over 4% p.a. growth over the last five years. Castrol’s earnings from outside the OECD markets have increased by over 250% since 2007. The company has been re-shaping earnings in the OECD as they aim to expand margins and secure customers through a focus on premium lubricants with advantaged formulation technology, and pursue efficiencies through differentiated routes to market.

Exhibit 38: BP-Castrol’s global lubricants pre-tax earnings (US$ million)

Source: Company, ICICIdirect.com Research

Exhibit 39: BP-Castrol’s global downstream performance

Source: Company, ICICIdirect.com Research

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Exhibit 40: BP-Castrol’s global premium lubricants sale as percentage of its total lubricants sale

Source: Company, ICICIdirect.com Research

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RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Strong Buy: >15%/20% for large caps/midca ps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%;

Sell: -10% or more;

Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) – 400 093 [email protected]

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