Castrol - A well lubricated engine

A caveat: “Business I admire” should not be translated as “Stocks I’m buying” and definitely not as “Stocks I’m recommending”. I generally buy the businesses I admire when they are selling at prices that give me unfairly high chances of making money.

If there is one Indian business which, in my opinion, fits the description of what Buffett would would find attractive, it is Castrol.

A bit of history. In 1899, C.C.Wakefield started a company in his name, to compete with his former employer, Mobil Oil. (Disgruntled employees are sometime dangerous!). The company started selling automotive lubricants under the brand of Castrol in 1909. In 1919, Castrol setup its only overseas branch office in India and commenced operation. In 1983, the company got listed in India. Before 1991, Castrol India could only make a limited amount of lubricant owing to the quota system. Due to this they focused only on superior products at premium prices. After economic liberalization in 1991, Castrol widened its network and its volume share went up. Today Castrol is major player in the Automotive lubes market and holds a market share of approximately 21% in the overall market. Its parent Burmah-Castrol was acquired by the BP in 2000. After acquisition, Castrol has retained its separate identity. Castrol branded lubricants continue to be sold around the world and are, in many countries, market leaders.

Castrol operates in a segment which is a low involvement product for the consumer and it is too much to expect brand loyalty. The company, however, has managed to build a strong brand which was acknowledged as a Consumer Superbrand for in the recently concluded survey by Superbrands India Pvt Limited.

The company’s competitors are PSU oil companies(IOC, BPCL, HPCL) which have their own lubricant brands. These companies together own more than 90% of retail network for retailing petroleum products. Despite that Castrol has managed to out compete the PSU brands and that speaks a lot about the strength of company’ products.

Castrol is not immune to downturns. The key raw material in making lubricants is base oil whose is derived from crude oil. The spurt in base oil prices increases the cost for materials. The company has strong brand to be able to pass the cost to the consumers but its competitors are PSUs whose business decisions are often driven by political compulsions and they have often resorted to unprofitable pricing. In year 2000, the net profit of Castrol fell from Rs 204 crore in 1999 to Rs 108 crore in 2001 when PSU oil companies did not revise their product prices despite increase in base oil price. Castrol recovered later and its profits went up from that level to 262.3 crores in year ending December 2008. The revenues doubled in the same period. As the PSU companies started losing money retailing their petroleum products, they have avoided price wars in lubricant market. The company has managed to increase the prices of its products without affecting the volumes significantly and the margins have remained around 20%. With drastic fall in crude prices, the base oil prices are expected to follow suit and the company will see reduction in cost of materials.

Another reason to worry is the decline in the volumes. Commercial Vehicle Original Equipment Manufacturers (OEMs) have made changes to their recommendations on oil drain intervals i.e. the distance traveled before oil change. Tata Motors introduced new oil drain specifications for their Heavy and Medium Commercial Vehicles for both crankcase (Engine Oils) and transmission Lubricants. The engine oil drain period has been doubled to 36000 kms while the transmission oil drain intervals have risen to 72000 kms. These specifications will reduce the engine oil consumption per vehicle which will translate into lower volumes for Castrol. So much for the bad news. Despite all this in the long run the economics of this business are quite attractive. The market size of automobile lubricants is a function of the total number of vehicles on road and does not vary as much as the annual vehicle sales figures. Mathematically, a sum of a timeseries will have lower volatility compared volatility of the series itself. This results in slow and steady growth for lubricant market. In India the total number of vehicles on road, will rise at a decent pace in coming decade. The emergence of small low cost cars, decreasing size of family units, multiple car ownership, rising incomes and improved infrastructure are all going to help increase the car ownership rates in India.

At the same time, Indian people have high levels of emotionally attachment with their cars. This helps in warding off commoditization of the lubricants. In commercial vehicles and industrial segments the market is already commoditized. However, the customers believe in the superiority of Castrol products and the value proposition helps the company in retaining its market share.

Castrol goes a long way in trying to build a bond with customers. In 2006, it started Castrol Bikezone a chain of multibrand two wheeler service centres. Although Castrol would like to see it as a growth area but I’m not too sure about thus. Still it’s a better way to get close to your customers rather than spending your marketing dollars in sponsoring cricket tournaments. Time will tell whether it turns out to be a good move.

Perhaps investors understand the strength of Castrol. That is why Castrol’s price hasn’t fallen at all in this downturn. At 309.7 Rs, it’s selling at 14.6 times its profits and 6.2 times it’s estimated book value(FY 2008). The valuations look high but look at the figures closely. Castrol earned 262.3 crores, when its networth at the beginning of the year was 475.5 crores. That too without any debt. This translates into 55% return on networth. In hasn’t diluted its equity for years. In past 5 years it has paid back as much as 75% of its profits as dividends. Last year it paid 15 Rs as dividends which gives you 4.84% dividend yield at current price.

The only reason I hate Castrol is that it refuses to fall. I bought the stock at Rs 235 in January 2008 and sold it at 330 nine months later when all others were falling like nine pins. I must admit that I violated my own principles while selling it in the hope to buy it back cheaper but that opportunity has eluded me so far. Hopefully, sooner than later, I’ll admit my mistake or Mr. market will come to redeem me.


a. 7 year financial data

b. Charts


Amit said...

Hi Kamlesh,

Nice blog..Did you ever look at the long-term record for Colgate India? I guess it would also qualify as one of the top businesses (although grossly valued currently) in the country.

Kamlesh Pandey said...

You are right. Colgate has a strong brand, impressive track record but it's too pricey for my taste.

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