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Buy Castrol India Ltd For Target Rs.131

We initiate coverage on Castrol India (Castrol) with a HOLD rating and target price of Rs131. Castrol focusses on profitable growth in the low volume growth lube market. This has meant higher EBITDA margin, RoE and RoCE, but lower volume and profit growth than that of peers like Gulf Oil.

We estimate a strong 22% YoY rebound in volumes and 40% YoY in EPS on a low base in CY21E. Since Q4CY20, Castrol lubes are being marketed through the retail outlets (ROs) of parent BP Plc and Reliance Industries’ JV (Jio-BP). This RO network is set to expand ~4x to 5,500 over five years. This may mean stronger volume and earnings growth ahead and drive rerating of the stock.

* Focus on profitable growth meant no/low volume growth, but high margins and RoCEs:

Castrol focusses on profitable growth in the low-volume growth and highly competitive ~30-player lube market in India. Lube usage is declining as engines become more efficient leading to rise in drain period of vehicles. Castrol’s focus on profitability has meant its 5-year average EBITDA margin is 28.6% vs 16.8% for peer Gulf Oil, and RoE and RoCE are 80%-112% vs 38-33% for the same competitor. However, it has meant Castrol’s 5-year volume and EPS CAGR in CY14-CY19 is 1%-12% vs 11-24% for Gulf Oil.

* Strong rebound in volumes and EPS in CY21E:

Castrol’s volumes plunged 19% YoY, EBITDA margin fell 2.6pct points YoY, and EPS declined 30% YoY in CY20 as covid-induced lockdowns and restrictions hit volumes. However, there was a smart recovery in H2CY20 with volumes up 2% YoY and EPS down 15% YoY vs 38-48% YoY fall in volumes and EPS in H1. Castrol’s Q1CY21 EPS was up 95% YoY driven by 61% YoY and 16% QoQ surge in volumes fuelled by pent-up demand and strong EBITDA margin of 29.9%. We estimate Castrol’s CY21E volumes to be up 22% YoY and EPS up 40% YoY despite hit from second wave.

* Marketing through Jio-BP ROs may mean stronger volume and EPS growth:

Castrol lubes were marketed only in the bazaar segment of the automotive lube market, which accounts for 85% of its volumes. However, from Q4CY20, they are also being marketed through ROs of Jio-BP. This JV plans to expand its petrol station network ~4x over the next five years to 5,500 from the current ~1,400. Castrol’s volume growth may be 8.75% YoY in CY22E-CY23E vs the 5% assumed in base case, and CY09-CY19 and CY14-CY19 CAGR of 0-1%, if its lubes sales throughput in Jio-BP’s ROs is similar to that of OMCs. This may mean CY22E as well as CY23E EPS growth is stronger at 12% YoY vs 6-8% YoY in the base case.

* Valuation at 15x CY22E EPS:

Our target price of Rs131/share (4% upside) is based on 15x CY22E EPS of Rs8.8/share. In a stronger volume growth scenario, the fair value at 15x CY22E EPS would be higher at Rs138 (10% upside).

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