Castrol India Ltd’s shares have had a dream run since mid-June, more than doubling in value, although the broad markets have risen by only around 10%. In the April-June quarter, the procurement price of base oil, the key input for the firm, had fallen sharply to around $600 (Rs27,720) a tonne, from a $1,000 tonne in the January-March 2009 period. This was in line with the sharp drop in crude prices during that period.
The lubricants firm had taken a 3-4% price cut owing to falling base oil prices in January last year, but chose not to adjust prices after the drop in the June quarter. As a result, profit zoomed. Operating profit margin jumped from 23% in the March quarter to 31% in April-June.
Base oil prices rose to $750 a tonne in the September quarter and further to $900 a tonne in the December quarter. With the company keeping selling prices intact, margins fell to 25% and 20% in the September and December quarters. But year-on-year (y-o-y), the growth in profit has been huge, thanks to lower base oil prices in 2009. This is what has led to the rerating in the company’s shares.
For the year as a whole, operating profit rose by 44% despite subdued volumes. In the automotive segment, which accounts for around 85% of turnover, volumes were flat, while in the industrial segment, volumes fell. The industrial segment was affected partly due to the slowdown in the exports of auto component manufacturers and partly because of the drop in economic activity in the first half of the year.
Things are expected to look up this year, especially in the automotive segment, given the rise in auto sales. What’s more, the company has raised selling prices by 6-7% in January this year to offset the rise in base oil prices. While it may be difficult to maintain the 25% margins of 2009, profitability is likely to be higher than the 18% levels of 2008, when base oil prices had risen sharply.
Graphic: Yogesh Kumar / Mint
The company has also used the benefit of lower raw material costs to invest in advertising and sales promotion. These expenses rose by 53% y-o-y. It should help the company’s volumes this year.
Still, considering that margins are likely to drop, earnings growth is likely to be subdued in 2010. With the base having adjusted as far as base oil prices are concerned, the days of high profit growth are over. In that backdrop, the company’s valuations of 23 times earnings before the results were announced were clearly stretched.
While the firm’s shares corrected by 8.5% on disappointment with the reported profit figure, there seems to be room for further correction owing to rich valuations.