De-merger of high quality lubricant business to lead to value creation:
Demerger of the lubricant business from other unrelated businesses (mining, explosives & realty) under the erstwhile holding company indicates the promoter’s intent to create value for all stakeholders. The demerged entity will now focus on improving its market share through innovation and brand building initiatives. The lubricant business is relatively non-cyclical since their consumption is non-discretionary (B2C: 75% of sales) and is dependent on the total vehicle fleet in the country. The EBITDA margins have consistently increased from 7.7% in FY10 to 13.0% in 1HFY15 which highlights the company’s pricing power amid a challenging economic environment.
Gulf to outpace industry growth by 2-3x:
Over the last 4 years, Gulf’s volumes grew at a CAGR of 7% while industry volumes increased by 3%. Gulf aims to grow its volumes at 2-3x industry growth. Gulf’s capacity is slated to increase from 75,000 kl to 170,000 kl by FY16/17. This offers significant growth visibility which is absent in any other listed players. We expect Gulf to grow its volumes at 10% CAGR over FY14-17E.
Increase in market share to continue:
Gulf’s MS has increased from 4.4% in FY07 to 6.9% in FY14 in the bazaar segment (80% of market). We believe the company is poised to continue to gain MS on the back of investments in brand building, tie-ups with OEMs and expansion of distribution network. Gulf’s ad-spends have risen from 2.5% in FY07 to 7.1% in FY14. Gulf’s distribution outlets have grown from 30k to 55k in the last 6 years and the management aims to take it to 75k in the next 3-4 years.
Valuations & View:
Earlier, the high-quality (high margin with pricing power, strong return ratios and healthy free cash flow generation) business of lubricants was clubbed with the other low-margin businesses of Gulf Oil Corp. Hence post-demerger, we see potential of value unlocking in the demerged entity, as it would be now directly comparable to Castrol. Castrol has an enviable ROCE of 37%, it offers significantly higher earnings growth of 24% CAGR and trades at almost half of Castrol’s valuation at 22x Sep 2016E. We believe that Gulf deserves better valuations and thus value it at INR 600 at 27x Sep 2016E EPS (30% discount to Castrol).