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Second wave, rising base oil prices affect profitability

About the stock: Castrol India, a subsidiary of BP, operates in the lubricants business and caters to automotive and industrial segments.

* Automotive segment volumes contribute 85-90% of total sales volume

* Castrol has high pricing power and commands premium for its products

Q2CY21 Results: Castrol’s Q2CY21 profits were sharply up YoY (on a lower base) while QoQ results were impacted by a drop in sales volume.

* Revenue was up 81.3% YoY to | 889.6 crore. Volume grew ~55% to 45 million litre

* Gross margins increased ~14% YoY to | 98.8/litre, supported by higher realisation. Subsequently, EBITDA/litre was | 43.9/litre, up ~34% YoY

* EBITDA came in at | 197.5 crore, up 107.2% YoY. Subsequently, PAT grew 114.1% YoY to | 140 crore.

What should investors do?

Higher base oil prices are likely to impact profitability in the near term. Potential disruptions like higher drain interval, EVs will be key monitorable for long-term volume growth.

* We downgrade our rating from HOLD to REDUCE on the stock

Target Price and Valuation: We value Castrol India at | 130 i.e.15x CY22E EPS.

Key triggers for future price performance:

* Although Castrol will report volume growth YoY in CY21E (on a low base), lack of sustainable volume growth in future will limit overall growth

* While the company has hiked retail prices in Q2CY21, high base oil prices will affect margins. With margins already at higher levels, we see limited headroom for gross margin growth from here on

* Castrol 2-W volume (26% of volume mix) are likely to be impacted with introduction of 2-W EVs.

Alternate Stock Idea: Besides Castrol, in our oil & gas coverage we also like MGL.

* MGL is a beneficiary of India’s increasing gas demand and will continue to grow on account of steady volume growth, better pricing power and favourable regulatory scenario

* BUY with a target price of | 1,340

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