Rising costs pose a threat to Castrol India’s margins

Rising costs pose a threat to Castrol India’s margins

Castrol India Ltd’s performance for the next two quarters is likely to be under pressure. That’s because the lubricant maker’s key raw material is crude based and its prices have already risen to uncomfortable levels.

Though Castrol’s operating profit margins have improved by 160 basis points on a year-on-year (y-o-y) basis to 22.5%, they fell by about four percentage points sequentially. But the sequential decline in margins cannot be purely attributed to higher raw material costs. Advertising costs, too, rose sharply. According to an analyst, the increase in advertising spend could be attributed to the increase in sports events that Castrol sponsors.

In fact, total raw material costs as a percentage of sales have remained more or less the same sequentially (at 52%), but total other expenditure as a percentage of sales has increased by four percentage points to 21%. Having said that, higher raw material costs are a cause for concern in the near future due to rising crude oil prices. Total raw material costs increased by 21% y-o-y.

According to Ravi Kirpalani, director (automotive) and chief operating officer, “Base oil prices for the quarter have averaged at $1,050 per tonne (Rs47,460 today) against $900 per tonne for the corresponding period last year. By the end of the year, they had risen to $1,075 per tonne." For 2010, average base oil prices have risen by 18% y-o-y, he said.

For 2010, the company has performed well. Margins increased by 160 basis points to 26.7% during the year. Castrol is looking at a 15-20% average compounded annual growth rate in the next five years in its net profit.

To counter the impact of rising raw material costs, Castrol took a price hike of 7-8% in mid-December. But with volume growth flat in the last quarter and with projected volume growth of 2-3% in 2011, it’s unlikely to offset margin pressure, which will continue to act as a drag on the stock.