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Reduce Castrol India Ltd For Target Rs.131

Margin recovery key to outlook

Castrol India’s (Castrol) Q2CY21 EPS was up 114% YoY on a low base driven by surge in volumes and margins, but down 43% QoQ hit by fall in volumes due to covid second wave and margins due to inability to pass on cost rise. High raw material cost, which the company indicated was up ~70% in Jun’21 from Q4CY20 levels, and hit from covid third wave, if any, are risks to outlook. Downside appears likely to CY21E EPS due to lower EBITDA margin than 28% (26.5% in H1 and 22.2% in Q2CY21) estimated by us but we keep earnings estimates unchanged for now. CMP implies 6% downside to our target price of Rs131. Given the headwinds, we downgrade the stock to REDUCE from Hold.

* Q2CY21 EPS up 114% YoY on a low base; down 43% QoQ hit by volume and margin fall: Q2CY21 EPS was up 114% YoY on a low base driven by 55% YoY rise in volumes to 45mn ltr and 34% YoY rise in EBITDA margin to Rs43.9/ltr. However, Q2 EPS was down 43% QoQ hit by 26% QoQ fall in volumes from record high of 60.5mn ltr and 22% QoQ fall in EBITDA margin from Rs56.2/ltr; margin was hit as material cost and opex rise at Rs21.8/ltr exceeded realisation rise of just Rs9.5/ltr. Q2 EBITDA margin was up 280bps YoY but fell by 767bps QoQ to 22.2%.

* Earnings estimates unchanged; downgrade stock to REDUCE: We keep our CY21E EPS estimates, which factor 22% YoY rise in volumes (up 55-58% YoY in Q2-H1CY21 on a very low base and implied 4% YoY fall in H2CY21E on a high base) and EBITDA margin of 28%. Castrol appears on track to meet our CY21E volume estimate and may even exceed it, unless there is a third wave of covid, which leads to lockdowns and affects volumes. Downside to our CY21E EBITDA margin estimate of 28% appears imminent given it was just 22.2-26.5% in Q2- H1CY21 and the fact that raw material lube oil base stock (LOBS) prices are up 69% from US$650/t in Q4CY20 to US$1,100/t in Jun’21. EBITDA margin of 26.5% in CY21 (same as in H1CY21) would imply a downside of 6% to our CY21E EPS estimate. Our target price of Rs131/share based on 15x CY22E EPS of Rs8.8/share implies 6% downside to current market price. We, therefore, downgrade the stock to REDUCE from HOLD.

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