Since its listing in July 2014, the stock of lubricants maker Gulf Oil Lubricants India has tripled. This year, it has gained more than 45 per cent.

This impressive rally has been on the back of the company’s healthy financial performance, faster than industry growth, and a catch-up in the stock’s valuation with that of larger peer Castrol India. In 2015-16, the company’s profit grew nearly 30 per cent year-on-year. Profit growth in the half year ended September 2016 improved further to 39 per cent year-on-year.

At ₹752, the Gulf Oil Lubricants stock now trades at about 32 times its trailing 12-month earnings, a tad higher than the average valuation of 29 times since listing. But this seems justified given the company’s strong showing and robust growth prospects.

Also, despite the run-up, the stock is cheaper than Castrol India that trades at 34 times the trailing 12-month earnings. Investors with a long-term perspective can buy the Gulf Oil Lubricants stock.

Healthy volume growth and benign costs — the key growth drivers — should continue. The upcoming plant at Chennai is expected to add to capacity in about a year from now. Initiatives to expand the distribution network and strengthen the brand should also help. Exposure to the stock, though, can be limited, given its small-cap nature (market cap of about ₹3,700 crore).

Growing volumes

Gulf Oil Lubricants gets about 80 per cent of its revenue from the automotive lubricants segment; industrial lubricants contribute the rest. The auto segment has been growing at a rapid pace the past couple of years resulting in healthy volume growth for Gulf Oil Lubricants.

During April to September 2016 too, overall auto sales volume growth was in double digits; in September 2016, growth accelerated to 20 per cent-plus levels, buoyed by festival demand.

The growth was broad-based across most categories in the passenger and commercial vehicle segments.

This has buoyed demand for automotive lubricants. Demand for industrial lubricants too picked up, thanks to increase in activity in some infrastructure pockets such as roads.

Gulf Oil Lubricants has been able to make the most of these favourable demand dynamics by consistently growing much faster — about two to three times — than the lubricant industry. The company’s volume growth in the recent September quarter, generally a weak period, was a healthy 10 per cent or so.

In a fragmented industry, the company has upped its market share steadily over the past few years, especially in automotive lubricants; it now has about 7 per cent share in the important bazaar trade distribution channel (retail outside petrol pumps).

Vehicle sales volumes should continue to rise briskly, aided by overall economic growth, good monsoon, Seventh Pay Commission spends and moderation in interest rates. Also, as economic activity picks up, demand for industrial lubricants should gain traction.

Automotive lubricant sales volume growth typically lags growth in vehicle sales due to increasing drain intervals — the recommended distance after which oil should be changed — for many vehicle types.

But Gulf Oil Lubricants should be able to grow at a healthy pace and continue with market share gains, with its expanding distributor network in urban and rural areas, new products including synthetic lubricants, and tie-ups with vehicle makers.

From January to September 2016, the company increased its retail distribution network by about 10 per cent to 55,000 retailers. It has recently tied up with Bajaj Auto to make and distribute oil for the latter’s vehicles among dealers and the bazaar network.

This is Gulf Oil Lubricants’ first OEM (original equipment manufacturer) tie-up in the two-wheeler segment. It has such tie-ups with some makers of passenger cars and commercial vehicles, and is looking to add more.

The company is well-positioned to meet the expected increase in demand. Its existing 90,000 mtpa plant in Silvassa is operating at about 85 per cent capacity, and the new 50,000 mtpa plant in Ennore, Chennai is expected to commence operations by the second or third quarter of fiscal 2017-18.

The new plant should help the company strengthen its presence in and around the auto hub of Chennai and other regions in South India.

Cost benefits

What also worked in the company’s favour over the past two years is the rout of crude oil. This cut the cost for base oil, the main raw material that is derived from crude. Base oil price change typically lags that of crude oil by two to three months.

Even as some of the cost benefit was passed on to customers to keep step with the competition, the company’s operating margin increased sharply.

This continued in the recent September quarter with the company’s operating margin rising to about 16 per cent from 15.5 per cent in the year-ago period.

Despite its recent rise, crude oil price is expected to remain in the range of $45 to $60 a barrel due to global oversupply and US shale oil cost dynamics. This should keep the price of base oil under control and help the company maintain its margins.

The company is funding the Chennai plant through a mix of internal accruals and debt. Its balance sheet position is strong with debt-to-equity comfortable at less than 0.5 times and cash reserves in excess of ₹200 crore as of September 2016.

With the major capex to be completed by the next year, margins should improve, thanks to operating leverage.

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