Given the rapid pace of industrialization and good growth in automobile sales, we are comfortable about the slow but sure growth prospects for lubricants market and business growth of Castrol over the medium term to long term. Lubrication industry is likely to grow by ~4-5 per cent over the next 2-3 years although there are challenges due to demand disruption on account of COVID-19 pandemic, intensifying competition, slowdown in global/domestic macro-economic factors and rising popularity of Electric vehicles(EVs). However, Castrol is in a strong position to withstand these challenges on account of its strong brands, technology and enduring relationships with key stakeholders. Following the implementation of BS-VI norms in the Industry, Castrol has launched BS-VI ready range of products across categories, which can also be used in BS-III/IV vehicles.
This range includes Castrol VECTON Long Drain 15W40 CK4 commercial vehicle engine oil, which is carbon-neutral certified and powers trucks with an extended drain interval of up to 1,20,000 kilometers. Apart from this, Its Silvassa plant expansion is on track and is expected to commence operations by 2021 (expansion from 100m liters to 140m liters). Although competition remains intense and the industry volumes are likely to grow in low single digits, Castrol enjoys strong brand equity, distribution and great operational/financial management.
Valuations & Recommendation:
In light of the possible onslaught by EVs, the company is looking at different revenue streams for the future. The deal with 3M is a reflection of the company's diversification into new avenues. This deal signed in May 2019 will to bring a range of market leading vehicle care products to the automotive after-market. A range of 3M-Castrol branded bike and car care products including shampoo, glass cleaner, cream wax, dashboard and tyre dressers will be available across India. In July2020, Castrol signed a deal with Jio-BP that will enable Castrol lubricants to enhance reach and visibility at 1,400 Jio-BP retail sites across the country, and sites are planned to expand to 5,500 sites in the next five years. Company is confident about prospects of its business in India over the long term and has decided to continue making investments in India unabated by recent slow growth. Lower crude oil and lube oil prices augur well for the margin trajectory. Overall the company faces challenges on volume growth front but the current valuation adequately discounts that. We feel investors could buy the stock at LTP and add on dips to Rs 106 –108 band (~12.5xCY21E EPS). Base case fair value of the stock is Rs 128 (15.0xCY21E EPS) and the bull case fair value of the stock is Rs 136 (16.0xCY21E EPS) over the next 2 quarters. At the CMP of Rs 116.7 the stock trades at 13.7xCY21E EPS.
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