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.

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.