Necessary but not Sufficient
Castrol - Brand
‘Hey Siddharth, how are you?’ Siddharth turned around as a voice called out to him.
He was at his home in Pune for the weekend and had gone out for a post-dinner walk. The weather was perfect, and he was lost in his thoughts when he heard his name being called.
It was Vishal, his high-school friend who stayed close by. He had come out for a walk too with his family.
‘Hi Vishal, good to bump into you,’ said Siddharth, ‘You’ve lost quite a bit of weight since we last met at our get-together.’
‘Yes, I have been coming for a walk after dinner every night without fail. That has helped,’ replied Vishal.
They chit-chatted for a couple of minutes. Siddharth could see that Vishal’s kids started getting restless.
‘You know what, are you going to be around tomorrow? Why don’t I pick you up and we can go for lunch some place and talk leisurely?’ asked Vishal.
‘Sure. I am around, give me a call,’ replied Siddharth.
‘Actually, you know how during our get-together, you had talked about the Peter Lynch framework and asked us to identify companies in our domain that we liked,’ Vishal continued, ‘I have identified a company ‘Castrol’ and wanted to see what you think.’
Vishal owned a Honda 2-wheeler dealership and Castrol was a well-known lubricant manufacturer. ‘It makes sense,’ Siddharth said, ‘Let’s discuss more when we meet tomorrow. I’ll read up on it too.’
‘Good night,’ Vishal said as he started walking and caught up with his family.
The next day, Vishal came on his Honda bike to pick up Siddharth. ‘I’ll show you my new dealership space first. It’s quite close by. Then we can decide where to go for lunch,’ he said ad Siddharth sat pillion.
It being a Sunday, in a few minutes, they reached Vishal’s dealership. ‘Well, here we are,’ Vishal said and they went in.
‘Wow Vishal, you’ve managed to grow your business quite a bit over the years. I remember you had a much smaller space the last time. I am impressed.’
‘Thanks, Siddharth. You know Pune is a city of 2-wheelers. So, business has been good,’ replied Vishal. He unlocked the door to his office and invited Siddharth to come in.
After spending a few minutes talking about how Vishal had grown his business, Siddharth asked him, ‘So you wanted to discuss Castrol India right?’
‘Yes, Castrol is a trusted brand. And Honda Motorcycle and Scooter India has endorsed CASTROL ACTIV Honda lubricants specifically designed for Honda’s two-wheelers in India,’ Vishal handed him a flyer.
‘That’s great Vishal,’ Siddharth said, ‘But can you give me a give backgrounder on the product. I mean I know what lubricants are, but you are the expert here.’
‘Sure. Lubricants play a major role in reducing friction generated by metal to metal contact. They also help in reducing noise and heat generation of metal parts - such as engines in automotive industry and cutting or honing parts in industrial applications.’
‘And how exactly do they do that?’
‘Well, detergents and dispersants in a lubricant help in cleaning, while anti-wear agents help protect the metal surface from wear and tear as well as corrosion. Automotive vehicles require engine oils, transmission fluids, brake fluids, hydraulic oils and greases. And industrial and manufacturing applications require lubricants for metal working, rust preventives and coolants.’
‘How are lubricants manufactured?’
‘Lubricants are manufactured by blending base oils with additives.’
‘So, can a company really differentiate itself in the manufacturing of lubricants?’
‘You need to understand that this blending involves highly advanced formulations as per the specific purpose the lubricant serves. And these formulations are in line with the Orignal Equipment Manufacturer (OEM) specifications and industry norms.’
‘And Castrol has been doing this for a long time?’
‘Castrol India has been around for more than a century. We have been using Castrol products for as long as I can remember for vehicles which come in for servicing. I think it’s a great company,’ he continued enthusiastically.
‘OK Vishal. You’ve been in this business for more than 20 years now,’ Siddharth told Vishal, ‘So, I am happy to go with your assessment that Castrol is a great brand and a great company. What we need to see is if it can be a great stock too for you as a shareholder.’
‘Yes, that’s where I need your help.’ agreed Vishal, ‘How do we evaluate it in an unbiased manner?’
‘Sure, we can do that,’ Siddharth replied, ‘Let’s first see how the stock price has performed historically.’
Vishal unlocked his PC and Siddharth guided him as to how he could bring up Castrol India’s stock price chart.
‘Actually, as you can see, Castrol’s share price hasn’t really done well over the past decade. It was at Rs 108 in 2010 and it is at Rs 122 now,’ Siddharth pointed out.
‘But how is that possible?’ Vishal couldn’t believe his eyes. ‘I thought with the brand and the trust they have, it would be what you call a multi-bagger,’ he was disappointed.
‘A brand is necessary but not sufficient for a multi-bagger,’ Siddharth explained.
‘Don’t get disheartened. It’s still important to analyse why the stock has behaved in this way. In the end, if you understand the reasons properly, you can take a call whether to move on or else take a contrarian position in the stock, expecting it to turn around,’ Siddharth consoled him. ‘And in any case, you can use this as a learning experience to analyse stocks on your own and identify multi-baggers.’
‘Yes, that makes sense,’ Vishal felt better, ‘Let’s spend some time on this.’
‘OK. The starting point of the analysis is to look at the opportunity size, whether it’s growing or not, and Castrol’s market share,’ Siddharth explained. ‘Here, let me open up Castrol’s FY20 Annual Report. I am sure it will provide us some figures. And you can add your expert opinion.’
‘Sure,’ Vishal sounded a bit enthusiastic now.
‘Here,’ Siddharth pointed to a section of the Annual Report, ‘We can see that India is the world’s third largest lubricants market after US and China with approximately 2.7 billion litres of annual consumption.’
‘Wow, that’s a lot. I’ve never thought of it beyond our requirement.’
‘Also, the lubricants market in India is highly competitive and fragmented comprising national oil companies, several international majors and a large number of local companies.’
‘Yes, I know of a few other brands in the market such as Servo, Shell, Mobil, Valvoline, etc. We only stick to the known brands.’
‘The overall automotive lubricant demand grew marginally at less than 1% in 2019 compared to 2018. This growth is driven by the expansion of vehicle population as well as the usage of vehicles in the country. However the commercial segment demand reduced in the year due to several macroeconomic factors.’
‘That’s not a good sign. The growth rate is very low, right?’
‘Yes. And economic activity has been slow for a few years now. So, we have identified one potential reason for the stock price movement – a market that is growing slowly.’
‘Good observation.’
‘What’s Castrol’s market share?’
‘Castrol India is the 2nd largest manufacturer of automotive and industrial lubricants in the Indian lubricant market. It has around 20% market share.’
‘That’s good. How have they done that?’
‘The Company operates in all major categories such as automotive, industrial, and marine & energy applications. It has a well-entrenched position in retail automotive lubricants and a significant presence in specialized industrial lubricants.’
‘OK. We have a good idea of the market size and growth, and Castrol’s share. Let’s take a closer look at the company’s business model next…’ said Siddharth.