Date: August 4, 2000
Castrol India Ltd. - Sell this…oil, stock and barrel
Current market price - Rs264.30
BSE Sensex - 4186.16

How many times in your life have you been advised to sell an MNC oil company which is cash rich, has premium brands and is a leading market player in its industry? - Your claim of never is acceptable for who would want to butcher the golden goose for lunch. Nevertheless, here we demur and implore you to read the story of transformation of the golden goose into the white elephant rechristened Castrol India ltd.

What is the business?
Castrol sells Lubricants. In fact it is the leading private player with 20% market share in an industry which has 32 players fighting to survive. And its clutch of premium brands kept the Castrol machinery well oiled in its campaign to takeover the industry. In an industry which had just about 5 players in the past, Castrol's formula for making the moolah in the market, was simple - offer a high quality lube and at the same time maintain volume share while increasing the price realization - and the money will flow in. And it actually did till end-1999, when the first nail was hammered in. With base oil prices, the chief raw material, escalating, Castrol was bludgeoned with higher cost unlike the competing PSUs who made their own base oil. So what did it do? As was its habit, it raised the price of its lube. Raising volume was still nowhere in its game-plan. Therefore as the British company talked about the weather and were researching into how much the traffic could bear, the PSU oil companies (with 60% market share) and the MNCs moved in with their lower priced variants. Margins slipped and market share began to dwindle. However, the coup de grace will be delivered only in the times to come. For one, Castrol will not be able to raise volumes as the industry is expected to grow only at 3%. For another, it will not be able to raise prices as the traffic is bursting its seams. With base oil prices rising, costs will see a further hike, squeezing margins further. Add to this the improving technology in the automobile industry reducing the drain between two fills (notwithstanding the stagnant automobile industry) and the verdict was clear - the sun had finally set on this British company.

Who is the Management?
Originally controlled by Burmah Castrol, the management control passed into the hands of BP Amoco, when they were took over Burmah Castrol towards the end of 1999. An average RONW of 43% (for the last 4 years), an average EPS of Rs21.6 (for the last 4 years) and instances of 200% dividend payments have characterized the management's philosophy. And why not? Sales were good, premium branded lubes was in demand and if volumes fell, the price realization was hiked so that everything still balanced. And as far as the dividend went, the company had no choice because it could not repatriate the same. All MNCs, if we may add, paid fantastic dividends more by default than by choice. But what they failed to decipher was the shifting sands in the industry. They never foresaw the industry slowdown, the increasing base oil prices, the non-viability of sustaining growth by just raising prices and finally the quintessential British upper lip refusing to believe that the PSU oil companies can become anything more than frivolous competition. So what if, for Castrol worldwide, its Indian operations ranked second in volume and third in profit terms respectively, next only to USA and Germany? We will not subsidize base oil for them; The Indian arm must fend for itself, so said the management and they went back to the weather and their tea. Noble philosophy, we agree, but when your subsidiary is drowning??

Whither cash flow?
For Castrol cash has never been a problem. It has generated oodles of it during its time, with a huge chunk contributed by the ballooning bottomline. (Of course it is a different matter altogether that the tax holiday Castrol enjoyed by virtue of setting up plants as in Silvassa, did play a rather large part in raising the bottomline). But the greater problem facing them is the use of the cash. For one it already has a well-entrenched distribution network (75000 retail outlets across the country), for another they have no capex plans since the industry is crawling at a snail's pace of 3%. Yes, it stands for the management that they had chosen to pay back a part of the excess cash to the shareholders, but questions still remain. Will the management be forced to make phyrric investments? Will it repatriate the cash back to its British parent? Will it be bitten by the dot-com bug? We do not have the answers but as far as its lube business is concerned, it throws up frightening prospects. For, when a business does not need cash, the oxygen for growth, it ceases to exist.

Why should I sell?
With the market discounting the stock at a P/E multiple of 16x, we advise a strong sell on this stock. Last year, Castrol had exhibited a topline growth fueled primarily by a 7% growth in price realization and 3% growth in volume. And that is the last time, we believe that it will see these growth rates. Let us take you through the rigmarole. For the coming year, any growth in price realization is out of question (more so with increasing competition from the PSUs). Read this in conjunction with the increasing cost in the form of base oil prices (expected to hover around $324/ton as compared to $180/ton last year) and low growth in volumes (for Castrol it is expected to be low as 2%) and the results are startling. Even if the company does maintain its 20% volume share, the earning are going to crash by 30%! And that is only for the coming year. And with the British parent exhibiting a stoic step motherly attitude in the form of non-interference (or indifference), the Indian arm is sliding on extremely thin ice. The picture does look bleak - little or no volume rise, no hike in price realizations, rising base oil prices and stiff competition. Well… it is true that Castrol India Ltd. had a past and a sterling one at that but so did Mohenjodaro and Harappa.

Where can I go wrong?
To tell you the truth, we believe that you will never go wrong. But the future being as unpredictable as the human behaviour, there may be an outside chance. If volumes do pick up or if base oil prices crash or better still if Castrol can command higher prices and all of Castrol's competition disappear, then… perhaps then, we have seen it all.

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