Castrol’s profitability hit by rising costs

The economic slowdown and inflationary pressures have weighed on Castrol India Ltd’s financial performance in the March quarter. Higher prices of the raw material—a derivative of crude oil being the key one—have adversely affected profitability of the lubricant maker. Current elevated crude oil prices offer no comfort for its forthcoming earnings as well.

Castrol’s total raw material costs as a percentage of revenue increased by 588 basis points in the March quarter on a year-on-year basis. Thus, operating profit margin fell by 383 basis points to 20.3%. A basis point is one-hundredth of a percentage point. For the past several quarters, falling operating margin has become a harsh reality the company has had to deal with.

While operating margin for the March quarter is flat sequentially, the metric is lower compared with calendar year 2011 when it stood at 22%, which itself was lower compared with 2010. Given that, it’s evident that a correction in crude oil prices and favourable currency movements will help improve the margin position.

Revenue growth in the March quarter was lacklustre at 4% to Rs784 crore. That’s lower than the 11% revenue growth seen in the December quarter. In the March quarter, the non-automotive segment, which contributed around 14% to the total revenue, increased at a relatively faster pace (high single-digit growth) than the automotive business, which contributes the remaining share to revenue. Earnings of both the businesses before interest and tax fell in the March quarter.

Net profit declined by 10% to Rs123 crore, again a poor show compared with about 1% improvement in the December quarter. Operationally, the situation is expected to be muted for Castrol, at least from a near-term perspective.

Investors, though, are unlikely to be too concerned. Some reasons for that include the company’s strong balance sheet (nil debt on the books), wide distribution reach and a strong brand name.

Not surprisingly, the Castrol India stock has risen by 28% this calendar year against the 12% increase in the benchmark Sensex. At Rs532, the stock trades at 18 times its estimated earnings for 2013, according to the estimates of Kotak Securities Ltd. Current valuations seem to be factoring most of the positives, and accordingly, triggers for outperformance appear limited going forward.

What’s heartening, though, is that raw material cost as a percentage of sales declined sequentially. Investors will be watching to see if that trend continues.

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