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| Summary of Contents | VIEWPOINT Gulf Oil Lubricants
Current market price: Rs460
View: Positive Melting crude puts it in a sweet spot Key points - Falling input cost to boost earnings as well as our confidence in GOL: During the first week of September 2014, we had initiated soft coverage on Gulf Oil Lubricants (GOL) with a positive view in the Viewpoint report titled "Re-structuring to lead re-rating in line with peers" in which we had talked of a healthy earnings growth of about 17% (supported by incremental capacity and falling crude prices) and a re-rating post-demerger from the parent company. Since then the stock has appreciated sharply fuelled by a sharp fall in global crude oil prices as base oil (a derivative of crude oil) is the key raw material for the company. The fall in the crude oil prices has been much sharper than our and the Street's expectations. Hence, we have tried to work out the potential impact of the falling crude oil prices on GOL's earnings and re-examine our stance on the stock. We believe that the softening of crude oil prices over a period of six to nine months will boost the earnings and margin of GOL in H2FY2015 as well as our conviction in the stock.
- Crude oil is down by about 30%; likely to remain weak in near term: The Brent crude oil prices have melted down by around 30% in the last one quarter to $75 per barrel. The global oil prices had already been softening because of higher supply (US shale and fracking induced crude oil production is at a 27-year high); now the Organisation of Petroleum Exporting Countries (OPEC)'s decision to maintain the current production of 30 million barrels a day brings fresh weakness in the commodity. Historically, production cuts by OPEC halted the fall in crude oil prices but in view of the recent decision of the OPEC the global crude oil prices are expected to remain weak for a couple of months at least. Besides, the supply improvement in the USA because of the Shale technology is a fundamental change that will not be reversed anytime soon.
- GOL could retain some benefit; fair chance of earnings revision: Historically, prices of base oil moved with a 0.9x correlation with crude oil prices; hence we expect the price of base oil (input for GOL) to fall sharply, though with some lag. Consequently, we expect the margin and earnings of GOL to improve in H2FY2015. However, we don't rule out that the event could trigger a price cut among its peers (the other lubricant players) due to their attempt to pass on some of the benefits to customers. Nevertheless, we believe that by virtue of selling branded products and not commodity oil, lubricant companies are well placed to retain part of the benefit at their end. Moreover, given the overall improving macro environment in India which indicates a demand recovery in the consumer industry (automobiles), there are chances that these companies would not go for a sharp cut in prices and would prefer to retain some benefit.
- Positive stance retained: We have run a scenario analysis to understand the impact of the event on the earnings of GOL in case it cut prices and passes on the benefit partially to the customer. As per our likely scenarios, the earnings per share (EPS) of GOL could vary between Rs24 and Rs29 in FY2016. Given the potential earnings growth of above 20% in the next two to three years and a sustainable hefty return on equity of 40%, the price/earnings (PE) multiple of 20x looks justified for GOL. Moreover, post-demerger there is a re-rating lever for the stock as now it is a pure play on the lubricant space where the benchmark leader (Castrol India) trades at a PE of ~35x. Hence, we expect the stock to deliver returns of another 15% or so from the current level and remain positive on the stock despite the recent run-up in its price.
| | Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article. | |
| Regards,
The Sharekhan Research Team |
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