COMPANY UPDATE 03 DEC 2015 Gulf Oil Lubricants …breport.myiris.com/hdfc/GULOILLU_20151203.pdfCOMPANY UPDATE 03 DEC 2015 Gulf Oil Lubricants ... Target Price : Rs. 632 . ... Tide

COMPANY UPDATE 03 DEC 2015

Gulf Oil Lubricants BUY

Friction free growth With a well-diversified and improving portfolio of lubricants, persistent brand building and distribution expansion, Gulf Oil Lubricants (GOL) is in an advantageous position to benefit from a cyclical revival in autos and GDP/IIP growth in India. The fall in crude prices will keep base oil (a key RM) costs low and gross margins high in the near term. Improving sales mix, operating leverage and logistical benefits can drive up margins in the long run.

We like GOL's (1) Consistent volume market share gains over established leaders, (2) Well-entrenched and expanding distribution network (~350 distributors, ~58,000 retailers), (3) Near doubling of capacity over FY14-17E, along with sustained investment in brand building (6-7% of sales).

We believe GOL is undervalued despite its low leverage, superior return ratios (FY18E RoE ~40.9%), multi-year market share gains, healthy dividend payout (~35%) and growth prospects. We maintain BUY with a TP of Rs 632 (25x 1-year forward rolling EPS).

Investment arguments

Strong focus on volume growth: The Indian lubricant industry is set to benefit from the revival in GDP growth. Advertising and brand-building efforts, expansion of retail reach and product innovations have helped GOL post 8.1% volume

CAGR over FY10-15 in a testing macro environment (industry volumes fell 1.6%). GOL’s target of outpacing industry volume growth by 2-3x looks achievable considering its track record and current initiatives.

Market share gains to continue: Unlike Castrol (the market leader), GOL is focused on volume growth and market share gains. It is currently ranked third, behind Veedol (Tide Water Oil’s brand). Through product development and brand building, GOL has improved its market share from 4.4% in FY07 to 7% in FY15 in the bazaar (retail) segment. Tie-ups with OEMs will give it a further boost.

Scope for margin expansion ex-crude: Lower base oil prices (67% of COGS) will help margins in the near term, but long-term gains will be driven by a better mix, operating leverage and savings in the freight cost (after the Chennai ramp-up).

Financial Summary YE March (Rs mn) FY15 FY16E FY17E FY18E Net Revenue 9,675 10,161 11,399 13,454 EBITDA 1,294 1,574 1,857 2,368 APAT 774 941 1,090 1,415 EPS (Rs.) 15.6 19.0 22.0 28.5 P/E (x) 31.1 25.6 22.1 17.0 EV/EBITDA 18.8 15.4 13.2 10.0 RoE (%) 41.4 43.9 39.9 40.9 Source: Company, HDFC sec Inst Research

INDUSTRY LUBRICANTS CMP (as on Dec 02, 2015) Rs. 485 Target Price Rs. 632

Nifty 7,931

Sensex 26,118

KEY STOCK DATA

Bloomberg GOLI IN

No. of Shares (mn) 50

MCap (Rs bn) / ($ mn) 24/361

6m avg traded value (Rs mn) 9

STOCK PERFORMANCE (%)

52 Week high / low Rs 566/367

3M 6M 12M

Absolute (%) (3.4) 5.7 (4.0)

Relative (%) (6.0) 9.6 4.2

SHAREHOLDING PATTERN (%)

Promoters 64.94

FIs & Local MFs 12.28

FIIs 7.08

Public & Others 15.70

Source : BSE

Mehernosh K. Panthaki [email protected] +91-22-6171-7340 Sachin Bobade [email protected] +91-22-6171-7329

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

mailto:[email protected]

GULF OIL LUBRICANTS : COMPANY UPDATE

Domestic lubricant industry offers strong growth opportunityStructure of the industry

With an annual lubricant consumption of ~2,020mn litre (5.4% of global consumption), India is the third-largest market in the world (in volume terms), after the US and China. The Indian lubricant market (excluding process oil) is currently estimated at 1,420mn litre per annum (LPA) and has declined by 1.6% on CAGR basis over FY10-15 owing to sluggish macros.

Automobile lubricants account for 67% (945mn LPA, with CVs contributing ~60%, and personal mobility ~40%). Engine oil is the largest category contributing nearly 2/3rd of the volume, while grease oil, greases and transmission fluid account for the remaining. The industrial segment (B2B), which includes core industrial sectors such as infra, mining,

marine, energy, etc. contributes the balance 33%.

Within the automotive segment, the replacement market is about 90%, while OEM channel accounts for 10%.

About 83% of the replacement market is dominated by bazaar/retail trade, which consists of distribution channels such as spare-part shops, mechanic workshops, dedicated lubricant dealers and OEM authorised service centres. The balance is contributed by retail petrol pumps.

Since fuel retailing at petrol pumps is almost entirely run by PSU refiners, private sector brands are absent in this segment.

Source: Company

Global Lubricant Market37.4 MMT

Indian Lubricant Market2.02 MMT (Value : $4.8 - $5.1bn)

Target Lubricant Market (exclProcess Oil)

1420 KT

Process Oil (White, Rubber, etc)

600 KT

Automotive945 KT

Industrial475 KT

OEM100 KT

Replacement845 KT

Retail Petrol Pumps145 KT

Bazaar Trade700 KT

67%

17% 83%

33%

10% 90%

The Indian lubricant market (excluding process oil) is currently estimated at 1,420mn LPA (67% automotives and 33% B2B) and has declined by 1.6% on CAGR basis over FY10-15 In the automotive industry, 90% is the replacement market (of which ~83% is dominated by bazaar/retail trade)

Page | 2


Channels Of Lubricant Sales In India

OEM Low-margin B2B channel for lubricant manufacturers. To strengthen their marketing presence in bazaar trade, manufacturers are aggressively tying up with OEMs

Bazaar Trade Profitable channel, as it has a wide distribution reach and better trade margins

- Spare-part shops Accounting for higher proportion of lubricant consumption (~40%) due to high level of consumer decision making on wide choice of product selection

- Mechanic workshops Witnessing shift to OEM ASCs, which have better brand pull and provide better service

- OEM ASCs Gaining traction over the past few years with a shift from mechanic workshops and petrol pumps

Petrol pumps Was dominated in early 90s by oil PSUs (90% of sales). However, post deregulation of the lubricant sector, the channel has been on a downhill, with bazaar trade (mostly private brands) gaining prominence

Source: Company, HDFC sec Inst Research Product Profile Of Indian Lubricant Players

Company Name Brand Products

2W PV Diesel engine oil

HPCL HP HP Super Brake Fluid, HP Racer

Hp Cruise, Hp Extra Super Motor oil

Hp Laal Ghoda, Milcy

BPCL MAK MAK 2T, Mak 4T Plus SL MAK Elite MAK multigrade, MAK gold plus IOC Servo Servo-2T, Servo-4T Servo-Pride tc Super multigrade, Servo-Xtrapremium, Pride 40

Castrol Castrol Activ, Power 1, Go GTX, Magnatec and Edge

GTX Diesel, CRB, CRB Plus, CRB Turbo, RX Super

GOL Superfleet Gulf Pride 2T, Gulf Pride 4T

Gulf Formula GX, MAX Supreme

Gulf XHD Plus, Superfleet LE Max, Super Diesel

Tide Water Oil Veedol Take-off, Super Swift Turbostar, Blue Blood

Turbopro, HDB, HDB Prima, HDB Multigrade, HDC Fleet, Heavy Pull

Total Total Total Elf Moto4 (Gold, TECH, MAXITECH, PRO)

Total Quartz, Quartz SMC

Elf Performance 3D, Elf Super HDB Turbo, Total Rubia, Total Transtech, ELF Super HBD Ultra, Total Tractagri XPL, XEP

Shell Shell Shell Advance Shell Helix Shell Rimula

ExxonMobil Mobil Mobil 1 Racing 4T, Mobil Extra 4T,Mobil Super 4T

Mobil 1, Mobil Super, Mobil Special

Mobil Delvac, Mobil Super, Mobil Diesel Special

Valvoline Valvoline Valvoline 4T Premium, MaxLife All Fleet, Premium Blue Source: HDFC sec Inst Research

With a wide distribution reach and better trade margins, bazaar trade is the most profitable channel at present OEM ASCs are gaining traction over the past few years due to better brand pull and the services offered

Page | 3


Volumes to improve with anticipated revival in autos and GDP/IIP cycle in India

Growth in lubricant volumes is directly linked to growth in auto volumes and IIP. In the past three years, the Indian lubricant market has been facing challenges in terms of slowdown in the GDP, automotive, infrastructure and industrial segments.

In automobiles, the CV segment was the worst performer - MHCV sales declined by 12.6% and LCV by 6% over FY12-15. Lower goods movement because of subdued economy, closure in mining and slowdown in infrastructure resulted in a large number of vehicles remaining idle.

PV volumes fell 0.2% over FY12-15, impacted by higher ownership cost. 2W sales recorded a growth of 6% over FY12-15, but it was slower than 21% over FY09-12. This was mainly led by high inflation and interest cost and slowdown in rural growth. (Source: SIAM and HDFC sec Institutional Research).

Slowdown in the auto industry, along with a shift in trend within the lubricant industry towards higher value, technologically advanced energy and fuel-efficient low-viscosity oils (long drain interval products), have further slowed down consumption.

We believe the worst is over and the lubricant

industry is likely to benefit from the revival in autos and GDP/IIP cycle over the next three to four years (as per GOL’s management, lube volumes typically grow 0.5x GDP).

Led by an expected decline in interest rates, lower inflation, revival in the capex cycle, and resuming of mining activities, we see a healthy recovery in the auto sector over the next three years, with sales volumes of CVs estimated to grow by 19% over FY15-18E, PVs by 11% and 2Ws by 7%. (Source: SIAM and HDFC sec Institutional Research).

While the demand for automotive lubricants may not keep pace with vehicle population growth, we expect it to be better than the previous three years (-2.2% over FY12-15). The industry growth in 1HFY16 stood at ~2%, driven largely by the personal mobility space.

Revival in the IIP and GDP cycle will result in demand uptick in industrial lubricants. Kline (a market research consulting firm) projects lubricant consumption in India to grow at 2.5% CAGR over the next five years.

GOL will benefit from distribution expansion, innovative product offerings, continued brand building efforts and capacity expansion.

Segments Growth drivers for auto sales, which would drive the demand for automotive lubricants

CVs Revival in the GDP growth, CAPEX cycle, road development and mining activities

PVs Decline in ownership cost, improving consumer sentiment and higher disposable income

2Ws Increasing income levels, wider product range available to customers, and easy finance options Source : Company, HDFC sec Inst Research

The lubricant industry is likely to benefit from the revival in autos and GDP / IIP cycle over the next three to four years Kline projects overall lubricant consumption in India to grow at a CAGR of 2.5% over the next five years

Page | 4


Low per capita consumption in India offers huge growth potential

The per capita lubricant consumption in India is quite low at ~1.2kg compared to ~5.3kg globally. Per capita consumption in developed geographies like the US and Europe is ~26kg and

~8.6kg, respectively. Even when compared to other developing countries like China (~4.6kg), there seems to be a significant potential for growth in lubricant consumption in India.

Per Capita Consumption of Lubricants (kg)

Source: Company, HDFC sec Inst Research

The per capita lubricant consumption in India is ~1.2kg compared with ~5.3kg globally Per capita consumption in the US and China (key lubricant markets) are significantly higher at ~26kg and ~4.6kg, respectively. Low per capita consumption in India leaves significant headroom for growth

4.6

8.6

25.7

5.3

1.2

0 5 10 15 20 25 30

China

Europe

US

Global

India

Per Capita consumption of lubricants(kg)

Page | 5


Branding, reach and product innovation to determine success

Industry shifting from volume to value-driven approach: In the early ’90s, the Indian lubricants industry was regulated and dominated by PSUs (90% market share) and a few private players like Castrol. However, post-deregulation, the industry has undergone a sea change in the past two decades.

Easing of base oil imports and bright prospects of India’s consumption growth story have led to entry of MNCs, thus making the industry more competitive. The volume market share of private players has increased, while PSUs have been constantly losing their space (28% share in the bazaar trade). Rising competition has also led to the emergence of technological advancements and improved product quality. Castrol and Mobil were early innovators, benefitting significantly from technological advancements. The industry is witnessing a shift from volume to value-driven approach.

Branding, distribution need huge investments; difficulty for new entrants: Today, consumers have become more brand conscious and are ready to pay a premium price for better quality lubricant oil (which ensures smooth functioning of the engine and longer vehicle life). The strategy in the Indian automotive segment has been shifting from the sales push, commodity-type marketing strategy to a brand pull, FMCG product-type of marketing. With increasing consumer involvement across bazaar trade, the product’s success will depend on how well it is

branded and distributed. This requires significant investments. With established PSUs and private lubricant players like Castrol, Mobil and GOL already ruling the market, new entrants will find it difficult to establish a brand image. Earlier, MNCs like Chevron had to pull out due to high competition.

Success driven by distribution strength, brand pull and product innovation: The Indian lubricant market is 82% organised with presence of over 30 established players. Some of the major players are PSUs like IOC, HPCL, BPCL, and private players like Castrol, Tide Water Oil, GOL and Exxon-Mobil. The companies with strong brand recall, wide distribution reach and product innovation skills have succeeded, while the rest have struggled.

This is evident from the fact that China, the second largest lubricant market after the US, has more than 3,000 lubricant enterprises, including more than 30 MNCs. However, most of them are small-scale enterprises without access to high-quality lubricant market, especially automotive. The market is dominated by state-owned, foreign-funded and private-owned enterprises. Sinopec (Great Wall Lubricant) and Petro China (Kunlun Lubricant) are top rankers, with a combined market share of ~49%. On the other hand, transnational tycoons like ExxonMobil, Shell, BP Castrol and others occupy 30%. (Source: China Lubricant Industry Report).

Rising competition has led to technological advancements and improved product quality The industry is witnessing a shift from volume to value-driven model Success will be driven by distribution reach, brand pull and product innovation, which will be challenging for new entrants China has over 3,000 lubricant enterprises, including more than 30 MNCs, but the market is dominated by only a few established players

Page | 6


Market share gains to continue with strong focus on volume growth Multi-year market share gains across the channels

GOL is the third largest private lubricant player after Castrol and Tide Water Oil. Driven by product innovations and brand building efforts, it has improved its market share (volume) from 4.4% in FY07 to 6.9% in FY14 in the bazaar segment (FY15 market share stood at ~7%). In the CV segment, the company commands a market share of 7-8%, in TW 8-9%, and PVs <5%.

The company’s market share in the overall lubricant industry has improved from 2.8% in FY07 to 4.6% in FY14, while in automotive segment it has gone up to 4.4% in 2007 to 6.5% in FY14.

Market Share in Bazaar Segment Market Share Gain Of GOL Across Channels

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Third largest private lubricant player after Castrol and Tide Water GOL has upped its volume market share from 4.4% in FY07 to 7% in FY15 in the bazaar (retail) segment

PSUs28.0%

Castrol21.3%Veedol

7.3%

Gulf6.9%

Total5.9%

Shell5.3%

Valvoline4.0%

Others19.0%

0.0

2.5

5.0

7.5

Overall Industry Automotive Segment

Bazaar Segment

FY07 FY14%

Page | 7


Targeting volume growth through product innovations, brand building efforts

Unlike Castrol, GOL’s focus is on volume growth. We are impressed with GOL’s consistent outperformance in volume growth (+8.1% CAGR) over industry (-1.6% CAGR) and the market leader, Castrol, (-1% CAGR) over FY10-15 through its innovative product offerings, continuous advertising and brand building efforts (A&P 6-7% of sales).

The lubricant industry is likely to benefit from the revival in autos and GDP/IIP cycle (as per GOL’s management, lube volumes typically grow

0.5x GDP). GOL is confident of outpacing the industry’s volume growth by 2-3x. Looking at its track record and its current initiatives, we feel this target is achievable.

GOL has been consistently launching differentiated and innovative products. The company was the pioneer in long drain diesel engine oils. In addition, it was the first to launch 10,000km drain interval motorcycle oil (Gulf Pride 4T Plus 20W-40) when others were at 5,000km.

A&P Spends Gulf Oil vs. Industry Volume Growth

Source: Company, HDFC sec Inst Research *6-7% A&P spends over FY09-14 is as given by management, since data is not available for the Gulf Oil Lubricants entity in the erstwhile Gulf Oil Corporation

Source: Company, HDFC sec Inst Research (*FY11 = CY10)

Volumes to grow 2-3x industry volumes As per the management, lube volumes grow 0.5x GDP GOL posted 8.1% volume CAGR over FY10-15 as against 1.6% decline for the industry The company was the first to launch 10,000km drain interval motorcycle oil (Gulf Pride 4T Plus 20W-40)

6-7 6-7 6-7 6-7 6-7 6-7

6

7

3

4

5

6

7

8

FY09

FY10

FY11

FY12

FY13

FY14

FY15

H1F

Y16

%

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

FY11

FY12

FY13

FY14

FY15

Industry Gulf Oil Castrol*

%

Page | 8


Brand-building Initiatives FY09 Association with IPL (Kings XI Punjab), Passenger Car Motor Oil (PCMO) / 4T advertising, Max range launch FY10 Appointed DDB Mudra as agency – ZNS (Zindagi Non-Stop) position evolved

FY11 Tie-up with CSK – launch of campaigns in the South, appointed MS Dhoni as brand ambassador and launched brand film with non-stop positioning

FY12 Continued IPL, ZNS and segment-wise campaigns with Dhoni

FY14 Launched 10 episode mini-series on CNN-IBN; leader talk to leverage communication of Gulf’s position in long drain lubricants and its long-standing association in cricket and motorsports

FY15 Gulf sponsorship of Zeeignition awards for automobile excellence (cars and bikes), expansion of bike stops, continued association with CSK in IPL, launch of digital campaigns across social media for TWs and PV segments, celebration event in India for Aston Martin Racing and drag bike racing global sponsorships

Product Innovations

FY07 (1) Launch of 36k km drain interval oil engine oil - Gulf Superfleet LE Max 15W-40 (when industry standard was at 16-18k km), (2) India's first 10k km drain interval motorcycle oil launched - Gulf Pride 4T Plus 20W-40 (when others were at 5k km)

FY11 (1) Gulf Super Diesel X-10, first co-branded product with M&M for 10k km drain period, (2) Launch of first ever 80k km drain interval Diesel Engine Oil - Gulf Superfleet LE Dura Max 15W-40

FY13 (1)) India's longest drain interval Rear Axle Oil for 150k km oil change period (as OEM Genuine Oil), (2) India's longest drain Gear Box Oil for 240k km change interval - Gulf MTF – PNG

FY15 (1) Launch of long drain engine oil for Mahindra tractors (Gulf XHD M Tractor) and Swaraj tractors (Gulf XHD S), (2) Launch of a specialised lubricant for the scooter segment - Gulf Pride 4T 10W-30

Steadily expanding distribution network

We are enthused by GOL’s well-entrenched and steadily expanding distribution network of over 350 distributors and ~58k retailers (up from ~30k in the past six years). Estimated universe of outlets, as per AC Neilson, will be ~1.5-2 lakh in urban India. There is huge scope for GOL to increase its distribution pipeline and help narrow the gap with Castrol (105k retailers).

In FY15, GOL launched the Gulf Rural Stockist (GRS) programme to strengthen its distribution in rural India. This model will be used to promote Gulf tractor and motorcycle engine oils. GOL plans to expand its reach by 8-10% p.a.

Distribution Network


GOL plans to increase its current distribution reach by 8-10% p.a.

58,000

105,000

0

20,000

40,000

60,000

80,000

100,000

120,000

Gulf Oil Castrol

Page | 9


Focus on driving 2Ws and PVs, with continued focus on CV segment

GOL derives ~70% of its revenues from the bazaar segment (automobiles), while B2B accounts for the balance 30% (of which 70% contribution comes from OEMs, largely automobiles, and 30% from industrial sectors such as mining, infra and marine).

GOL’s strategy to target focused segments - 2Ws and diesel engine oil - has been successful. In Tamil Nadu, the company is the No. 1 private player in long drain oil. In 2Ws, GOL has an 8-9% market share (no. 2 after Castrol), 7-8% in CVs 5% in tractors, and <5% in PVs. While the CV segment will continue to remain a strong growth catalyst, the company is looking at strengthening its presence in the personal mobility space (2Ws and PVs).

YTD Sept 2015 GOL’s motorcycle oil volumes are growing at 2-3x the market rate, which is encouraging. The revenue contribution of 2Ws in H1FY16 has increased to ~20%. GOL’s effort towards improving its branding, marketing and

distribution in the segment is yielding results. Further, GOL is focusing on strengthening the scooter lubricant category and has achieved product placement at more than 10% of its retail base in addition to the exclusive service points, Bike Stop.

Geographically, in the diesel engine oil segment, GOL is strong in the South and West and is present across all regions. However, it needs to focus on its presence in the North.

For motorcycle, the company’s presence in the South is weak. The region offers a good growth opportunity, especially with a new plant coming up in Chennai. In the PV segment, GOL is looking at increasing its presence in areas of Mumbai, which is dominated largely by Castrol.

The company has a target to increase its market share in the PV segment to 7-8% in the next three to four years. Personal mobility segment in the bazaar market gives better margin and improves branding.

Shift In Segment-wise Contribution


Diesel Engine Oil

63%

2W9%

Passenger Cars4%

B2B (OEMs,Indu

strial)24%

FY09

Diesel Engine Oil

45%

2W18%

Passenger Cars5%

B2B (OEMs,Indu

strial)30%

FY15

The company is looking at strengthening its presence in 2Ws and PV lubricant segments In CV, North is weaker, where GOL will focus on increasing its presence For motorcycle, presence in the South is weak. The region offers good growth opportunity YTD Sept 2015m GOL’s motorcycle oil volumes growing at 2-3x the market rate In PV segment, GOL is looking at increasing its presence in areas of Mumbai GOL has a target to increase its market share in PV segment to 7-8% in the next 3-4 years.

Page | 10


Capacity expansion at Silvassa and new facility in Chennai to boost revenues

GOL currently has only one facility at Silvassa with a capacity of 90mn LPA (expanded recently from 75mn LPA at a cost of Rs 440mn). Additional new machines for automotive filling have been started. Also, some infrastructure projects are partly done. Full benefits of the ramp-up will be visible from 2HFY16.

GOL is also setting up a 50mn LPA Greenfield facility at Chennai at a cost of Rs 1500mn. Rs 400mn has already been incurred towards land acquisition (15 acres) through internal accruals. The balance Rs 1100mn may be funded through a mix of internal accruals and borrowings.

Construction work is set to begin from 3Q/ 4QFY16 and commercial production is estimated

to commence by end-Jan 2017. With this expansion, GOL’s total capacity will increase to 140mn LPA.

Chennai is fast becoming a major auto hub with the presence of several OEMs. The ramp-up will enable GOL to come closer to its customers (30% sales volumes from the South) and capture huge OEM potential.

We feel the Chennai ramp-up will also result in decent savings in the logistics cost. GOL will cater to the South markets by manufacturing products largely from this new facility, while Silvassa will cater to the other markets.

The full benefits of this Greenfield expansion will start reflecting in the company's financials from 1QFY18.

Silvassa Chennai

Installed Capacity - FY14 75mn LPA -

Expansion plans 15mn LPA 50mn LPA

Status Already commenced during 4QFY15

Construction to begin in 3Q/4QFY16. Commercial production likely to commence by end-Jan 2017

Total CAPEX ~Rs 440mn ~Rs 1500mn. Rs 400mn towards cost of land has been incurred

Source of funding Funded through internal accruals and borrowings

Cost of land through internal accruals. Balance Rs 1100mn to be funded equally through internal accruals and borrowings


Silvassa capacity increased from 75mn LPA to 90mn LPA Greenfield plant in Chennai with 50mn LPA capacity being set up at the cost of Rs 1500mn Chennai ramp-up will help capture huge OEM potential and will also lower the freight cost

Page | 11


Tie-ups with OEMs to aid in volume growth and market share gains

Partnerships with key OEMs across vehicle types are a significant opportunity for lubricant players. Stronger emission norms and demand for fuel efficiency are driving OEMs to continuously develop new engine technologies. This is expected to translate into demand for lubricants with very specific physicochemical and performance properties, and opportunities to introduce more advanced lubricants.

Despite low margins in OEM tie-ups, GOL has been forging such partnerships as part of its strategy to improve volume growth and market share. The recent tie-up with Mahindra Tractors (an extension of relationship with M&M’s automotive division) helped GOL gain 1% additional market share in the tractors segment. In FY15, GOL tied-up with Schwing Stetter, a pioneer and leader in concrete construction

equipment, and with Whitmore, USA, for specialised greases for mining applications.

As part of its efforts to develop and deliver world-class products to its customers, GOL works closely with several OEMs and has even pioneered several go-to-market models in the automotive industry, including genuine oils (which ride on the vehicle manufacturer’s branding), co-branded oils (includes brand name of both lubricant manufacturer and OEM), and approved oils (approved and recommended by an OEM).

We expect more partnerships with OEMs in the coming quarters. We are confident of GOL capturing huge OEM volume potential post commissioning of the Chennai plant. These tie-ups will also help GOL strengthen its marketing presence in the bazaar trade.

OEM Tie-ups


Despite low margins in OEM tie-ups, GOL has been forging such partnerships as part of its strategy to gain market share Tie-up with Mahindra tractors helped GOL gain an additional 1% market share in the segment (total share 5%) GOL could capture huge OEM volume potential post the Chennai ramp-up Tie-ups with OEMs to help strengthen marketing presence in bazaar trade

Page | 12


Revenue growth to improve from 2HFY16 onwards The competitive scenario has intensified over the

past year leading to increase in discounts offered to the channel partners. As GOL responded to these new market dynamics, its revenue growth moderated towards the end of FY15.

While the volume growth in FY15 stood at 6.8% (outpaced industry growth, which was flat), price realisations were marginally higher by 2.6%. Overall revenue growth in 1HFY16 remained

subdued at 3% YoY, despite ~5% increase in the volume growth, largely due to price discounts.

We expect the revenues to grow by 11.6% on CAGR basis over FY15-18E. Volume growth is likely to pickup from 2HFY16, with anticipated revival in the auto segment and GDP/IIP cycle. While we don’t expect any major reductions in the price discounts in the near term due to increased competition, it is likely to be partly offset by an improved mix.

Sales Volumes Sales Value

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Discounts to channel partners have increased over the past one year with rising competition Volume growth to pickup from 2HFY16 with anticipated revival in the auto segment and GDP/ IIP cycle Improved mix to partly offset impact of price discounts

-4

1

6

11

16

21

0

20

40

60

80

100

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

Sales volumes (Mn Litres) - LHS Growth (%) - RHS

0

5

10

15

20

25

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

FY11

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FY14

FY15

FY16

E

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E

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E

Sales Value (Rs. In Mn) - LHS Growth (%) - RHS

Page | 13


Sharp decline in crude prices, a significant near-term margin lever Base oil is a key input used in the manufacturing

of lubricant oil and accounts for ~67% of COGS. Additives and packaging costs account for the remaining amount.

Some common additives (~22% of COGS) include metals such as lead or metal sulphide (enhance lube oil's ability to prevent galling and scoring when metal surfaces come in contact under extremely high pressures), high-molecular weight polymerics (improves oil viscosity) and Nitrosomines (employed as antioxidants and corrosion inhibitors, as they neutralise acids and form protective films on metal surfaces).

Base oil is produced by refining crude oil. Hence, decline in crude prices is highly beneficial to GOL. Ceteris paribus, 1% decline in base oil prices improves the company’s gross margins by 36bps.

As per Bloomberg data, base oil prices have fallen by 30% over the trailing year (vs. ~34% decline in crude oil prices). In 2QFY16, prices fell

by 34% YoY; ~30% drop in Q1FY16 and 28% in 4QFY15.

With the decline, gross margins having improved consistently from 38.7% in 1QFY15 to 44.8% in 2QFY16. The improvement could have been better over the past three quarters if not for the higher price discounts (RM benefits partly passed on) and the Rupee’s fall vs. US$ (down 0.7% in 4QFY15, 6.2% in 1QFY16 and 7.2% in 2QFY16). GOL imports 50% of its base oil requirements.

Base oil prices fell further by ~5% since start of Oct-15. Currently, base oil’s spread over crude is at US$ 43/bbl. We expect the prices to remain at lower levels with easing of supply constraints, low priced crude and higher spreads.

Assuming base oil prices remain at current levels, the benefit of soft base oil prices will continue for another 2-3 quarters. GOL, however, is unlikely to pass on these benefits completely, given an improving demand environment.

Gross Margins (%) Base Oil Price Trend

Source: Company, HDFC sec Inst Research Source: Bloomberg, HDFC sec Inst Research

-

50

100

150

200

250

Jan-

12M

ar-1

2M

ay-1

2Ju

l-12

Sep-

12N

ov-1

2Ja

n-13

Mar

-13

May

-13

Jul-1

3Se

p-13

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-13

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14M

ar-1

4M

ay-1

4Ju

l-14

Sep-

14N

ov-1

4Ja

n -15

Mar

-15

May

-15

Jul-1

5Se

p-15

Nov

-15

Base Oil Brent Prices SpreadUSD/BBL

As per Bloomberg data, base oil prices have fallen by ~30% over the past year (vs ~34% decline in crude oil prices) Base oil prices fell further by ~5% since start of Oct-15. GOL’s gross margins have improved from 38.7% in 1QFY15 to 44.8% in 2QFY16 Easing of supply constraints and low-priced crude will keep the base oil prices at lower levels in the coming months

37.3 38.4 40.2 40.844.5 44.8

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Page | 14


Structural levels provide good scope for margin improvement in the long run

We think there are structural levers that can drive the margins higher over the next three years. These include increased pricing power arising out of innovative and cost-effective brand building, improving sales mix and operating leverage. These levers could lead to a sustainable re-rating in valuations.

The Chennai facility will be in close proximity to India’s auto hub and port facility. This will result

in decent savings on freight as South India has the highest volume share (~30%) for GOL. However, full benefits will be visible from 1QFY18.

We expect GOL’s EBITDA to grow by 22.3% on CAGR basis over FY15-18. EBITDA margins are expected to improve by 420 bps from 13.4% in FY15 to 17.6% in FY18E.

EBITDA Trend EBITDA Margins


Structural levers such as pricing power, improved sales mix, operating leverage to drive EBITDA margins higher to 17.6% by FY18E

12.8 12.7 12.8 12.313.4

15.516.3

17.6

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Page | 15


Growing faster than the market leader; valuation gap to narrow Castrol’s stock price has witnessed a significant

re-rating over the past decade (market cap up 10x from Rs 24bn in CY04 to Rs 241bn in CY14) due to its strong brand equity, wide distribution network, margin gains (led by premiumisation) and FMCG-type business model.

While Castrol’s performance was impressive over CY04-09, its premiumisation strategy has not worked well in the past five years (CY09-14). Castrol’s pricing power has been eroded with rising competition, high dealer incentives, aggressive branding by relatively smaller lubricant players (like GOL and Tide Water).

Interestingly, GOL has outperformed Castrol in all parameters during FY10-15 (refer to table below). The company has benefited from its focus on improving volume growth. We expect this strategy to continue. This, along with initiatives towards continued investments in brand building, product innovation and distribution expansion, should help GOL grow faster.

While lower RMs should act as significant margin lever in the near term, GOL is in an advantageous position to improve its margins at a faster pace in the long run due to existence of structural levers.

Castrol’s sharp improvement in profits during 9MCY15 (EBITDA up 38.3%, EBIDTA margins up 711bps to 27.2%, PAT up 38.5%) is largely attributable to lower base oil prices. Sustaining such high profit growth could be challenging for Castrol, given the rising competition, its continued focus on premiumisation and absence of structural levers. RM benefits can weaken over the next few quarters.

Castrol’s premium valuations could sustain, given its leadership position in the personal mobility space, strong brand pull, distribution reach, product innovation skill and superior financial ratios. However, with faster growth and continued outperformance, GOL’s discount in valuations to Castrol could narrow going forward.

GOL’s Outperformance Over Its Peers

CAGR (%) Castrol Tide Water Oil GOL

CY04-09 CY09-14 FY10-15 FY10-15 Sales Volume (1.7) (1.0) 2.8 8.1 Net Revenue 11.6 7.8 9.7 11.6 EBITDA 23.9 4.1 (2.5) 21.8 PAT 29.8 4.5 (0.7) 27.6 Distribution Network 7.0 8.5 NA 10.8 EBITDA margins (%) up 1030 bps to 25.1% down 400 bps to 21.1% down 620 bps to 7.7% up 475 bps to 13.4% PAT margins (%) up 680 bps to 16.4% down 240 bps to 14% down 350 bps to 5.4% up 390 bps to 8% ROCE (%) up 3300 bps to 78.8% down 540 bps to 73.4% down 1740 bps to 11.4% NA Source: Company, HDFC sec Inst Research

GOL has outperformed Castrol since FY10. Its strategy of focusing on volume growth seems to have yielded benefits GOL is better placed to improve its margins at a faster pace in the long run due to existence of structural levers

Page | 16


Revenue Growth (%) Volume growth (%)

Source: Company, HDFC sec Inst Research *For Castrol FY11=CY10

Source: Bloomberg, HDFC sec Inst Research

EBITDA Margins (%) Volume Market Share (%)


GOL has outperformed both Castrol and Tide Water Oil in volume and value revenue CAGR over FY10-15. Castrol has superior EBITDA margins. However, GOL’s EBITDA margins have been improving, while those of Castrol & Tide Water Oil are witnessing a declining trend since FY11 GOL is ahead in terms of volume market share gains in overall lubricant market over FY11-15 (+160 bps to 4.8%), compared to Castrol (+20 bps to 13.7%) and Tide Water Oil (+90 bps to 4.7%)

0

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FY11 FY12 FY13 FY14 FY15

Castrol GOL Tide Water

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Ratio Analysis FY15 Castrol Tide Water Oil GOL Gross margins (%) 42.9 21.1 38.9 EBITDA margins (%) 21.1 7.7 13.4 PAT margins (%) 14.0 5.4 8.0 Cash Conversion Cycle (days) 10.4 78.4 60.0 ROCE (%) 73.4 11.4 21.9 ROIC (%) 356.4 12.6 37.0 ROE (%) 76.0 12.7 41.4 Net Debt-Equity (x) (0.9) (0.3) 0.2 Asset Turnover (x) 6.5 1.8 2.4 P / BV (x) 43.6 3.0 12.7 Dividend Payouts (%) 78.2 54.5 35.0 Interest Coverage (x) 306.0 150.0 7.0 Source: Company, HDFC sec Inst Research

Peer Valuations

Company CMP (Rs)

TP (Rs)

Mcap (Rs bn)

Diluted EPS (Rs) P/E( x) EV/EBITDA(x) ROE (%) FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E

Gulf Oil Lubricants 485 632 24 19.0 22.0 28.5 25.6 22.1 17.0 15.4 13.2 10.0 43.9 39.9 40.9 Castrol#* 443 - 219 12.8 14.5 16.1 34.6 30.4 27.5 24.3 20.9 18.8 103.2 113.9 116.9 Source: Company, HDFC sec Inst Research * FY16E=CY15E # Bloomberg estimates

Key risks to our thesis Input cost inflation: Sharp rise in crude oil prices

from current levels could result in higher base oil prices and impact GOL’s margins, especially if the company fails to pass on the cost inflation to the consumers.

Prolonged slowdown in the Indian economy: The Indian lubricants industry is expected to benefit from anticipated revival in the autos

segment and GDP/IIP cycle. However, any delay in revival could pose a risk to our growth estimates.

Sharp Rupee depreciation: GOL imports ~50% of Base Oil requirement, while its exports are meagre at 1%. If the rupee continues to slide further, GOL’s margins could be impacted. This will be more visible after RM benefits wane out.

Castrol’s financial ratios remain superior to GOL, but the gap has narrowed over the last five years in most ratios

Page | 18


Income Statement (Rs mn) FY15 FY16E FY17E FY18E Net Revenue 9,675 10,161 11,399 13,454 Growth (%) 9.7 5.0 12.2 18.0 Material Expenses 5,911 5,609 6,237 7,306 Employee Expenses 440 569 616 673 A&P Expenses 556 691 798 942 Other Operating Expenses 1,474 1,717 1,892 2,166 EBITDA 1,294 1,574 1,857 2,368 EBITDA (%) 13.4 15.5 16.3 17.6 EBITDA Growth (%) 19.6 21.7 17.9 27.5 Other Income 92 137 130 169 Depreciation 48 63 93 161 EBIT 1,338 1,648 1,893 2,376 Interest 178 213 243 232 PBT 1,160 1,434 1,651 2,144 Tax 386 493 561 729 APAT 774 941 1,090 1,415 APAT Growth (%)

21.6 15.8 29.9

EO items (net of tax) - - - - RPAT 774 941 1,090 1,415 RPAT Growth (%)

21.6 15.8 29.9


Balance Sheet (Rs mn) FY15 FY16E FY17E FY18E SOURCES OF FUNDS

Share Capital 99 99 99 99 Reserves 1,772 2,318 2,950 3,770 Total Shareholders’ Funds 1,871 2,417 3,049 3,870 Total Debt 2,156 1,856 2,206 2,106 Deferred Taxes 26 26 26 26 Long-term Provisions 22 25 28 33 TOTAL SOURCES OF FUNDS 4,075 4,324 5,309 6,035 APPLICATION OF FUNDS

Net Block 892 1,033 2,490 2,429 Investments 26 26 26 26 LT Loans & Advances 67 87 97 115 Inventories 1,416 1,489 1,624 1,880 Trade Receivables 1,141 1,072 1,187 1,364 Cash & Equivalents 1,804 1,652 1,661 2,363 ST Loans & Advances 190 180 202 238 Other Current Assets 25 21 24 28 Current Assets 4,576 4,414 4,698 5,874 Trade Payables 968 1,169 1,343 1,622 Other Current Liabilities & Provs 603 633 710 838 Current Liabilities 1,570 1,802 2,053 2,460 Net current Assets 3,005 2,612 2,645 3,414 TOTAL APPLICATION OF FUNDS 4,075 4,324 5,309 6,035


Page | 19


Cash Flow (Rs mn) FY15 FY16E FY17E FY18E Reported PAT 774 941 1,090 1415 Non-operating & EO items 62 90 86 111 PAT from Operations 713 851 1,004 1,304 Interest, Dep & Others 200 277 336 392 Working Capital Change - 224 (31) (80) OPERATING CASH FLOW ( a ) 913 1,352 1,309 1,617 Capex (355) (686) (1,035) (100) Free Cash Flow 558 666 274 1,517 Investments & Others (26) - - - Non-operating income 62 90 86 111 INVESTING CASH FLOW ( b ) (319) (596) (949) 11 Debt Issuance 2,156 (300) 350 (100) Interest (178) (213) (243) (232) Dividend (317) (395) (458) (594) FINANCING CASH FLOW ( c ) 1,662 (909) (350) (926) NET CASH FLOW (a+b+c) 2,255 (153) 9 702 Closing Cash 1,804 1,652 1,661 2,363 Source: Company, HDFC sec Inst Research

Key Ratios FY15 FY16E FY17E FY18E PROFITABILITY (%)

GPM 38.9 44.8 45.3 45.7 EBITDA Margin 13.4 15.5 16.3 17.6 EBIT Margin 12.9 14.9 15.5 16.4 APAT Margin 8.0 9.3 9.6 10.5 RoE 41.4 43.9 39.9 40.9 RoIC 37.0 37.5 32.1 40.0 RoCE 21.9 25.7 25.9 27.6 EFFICIENCY

Tax Rate (%) 33.3 34.4 34.0 34.0 Asset Turnover (x) 2.4 2.4 2.4 2.4 Inventory (days) 53.4 53.5 52.0 51.0 Debtors (days) 43.1 38.5 38.0 37.0 Payables (days) 36.5 42.0 43.0 44.0 Cash Conversion Cycle (days) 60.0 50.0 47.0 44.0 Debt/EBITDA (x) 1.7 1.2 1.2 0.9 Net D/E 0.2 0.1 0.2 (0.1) Interest Coverage 7.0 7.1 7.3 9.5 PER SHARE DATA (Rs)

EPS 15.6 19.0 22.0 28.5 CEPS 16.6 20.3 23.9 31.8 BV 37.7 48.8 61.5 78.1 DPS 5.5 6.6 7.7 10.0 VALUATION

P/E (x) 31.1 25.6 22.1 17.0 P/BV (x) 12.9 10.0 7.9 6.2 EV/EBITDA (x) 18.8 15.4 13.2 10.0 OCF/EV (%) 3.8 5.7 5.4 6.9 FCF/EV (%) 2.3 2.8 1.1 6.5 Dividend Yield (%) 1.1 1.4 1.6 2.1


Page | 20


Rating Definitions

BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period

NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period

SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period

Date CMP Reco Target 6-Feb-15 507 BUY 642 1-Jun-15 470 BUY 640 2-Dec-15 485 BUY 632

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Gulf Oil TP

RECOMMENDATION HISTORY

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Disclosure: We, Mehernosh Panthaki, CA and Sachin Bobade, BE, MBA, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Further Research Analyst or his relative or HDFC Securities Ltd. or its associate does not have any material conflict of interest. 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Page | 22

Documents

COMPANY UPDATE 03 DEC 2015 Gulf Oil Lubricants …breport.myiris.com/hdfc/GULOILLU_20151203.pdfCOMPANY UPDATE 03 DEC 2015 Gulf Oil Lubricants ... Target Price : Rs. 632 . ... Tide