Stock Call: Why you should buy Gulf Oil Lubricants

Lubricant maker Gulf Oil Lubricants India has managed to hold its own despite the downturn in the automotive sector — its key customer base that accounts for more than three-fourth of its business. The company’s net profit in the recent September 2019 quarter was up 54 per cent y-o-y at ₹ 62 crore, aided by better margins that offset weakness in volumes, and the recent corporate tax rate cuts.

Excluding the tax rate cut benefit, the company’s profit before tax was up about 11.5 per cent to ₹69 crore. In the June 2019 quarter, too, Gulf Oil Lubricants’ net profit grew about 21 per cent y-o-y to ₹49 crore, aided by higher volumes and better margins.

The good show in the bottom-line in the first half of FY2020 follows the nearly 12 per cent y-o-y growth in the company’s net profit in FY 2019 to about ₹178 crore that was driven by good volume growth.

Meanwhile, the Gulf Oil Lubricants stock has fallen about 20 per cent from its highs in early 2018, dragged down by concerns about the slowdown in the auto industry and the volatile market conditions that have hurt smaller stocks more. The dip though presents a good buying opportunity for investors with a high risk appetite and a long-term perspective.

One, the stock’s valuation seems attractive. At ₹ 813, it trades at about 19 times its trailing 12-month earnings, lower than the average of about 27 times over the past three years. Next, the company seems well positioned to tide over the troubles in the auto industry. That said, exposure to the Gulf Oil Lubricants stock may be limited; it is a small-cap stock with a market capitalisation of about ₹4,000 crore. Market uncertainties tend to take a bigger toll on such stocks.

Smooth ride

Gulf Oil Lubricants continues to outpace the overall lubricants industry on volume growth, and is increasing market share. This is expected to continue with the company’s initiatives on increasing its distribution reach, including in the rural markets.

Even as B2B factory-fill volumes from original equipment makers (OEMs) have been under pressure due to the auto industry slowdown and output cuts by automakers, Gulf Oil Lubricants has been able to grow volumes at a healthy pace in the B2C personal mobility space and in the infrastructure and industrial segments.

Besides, while it is hard to predict the trajectory of the auto industry, the worst could be over. An improvement in fortunes, especially in personal mobility vehicles, could be seen in the coming quarters with the April 2020 roll-out of BS-VI vehicles, an expected cut in personal tax rates, cheaper financing and a possible up-tick in rural incomes due to normal monsoons.

Commercial vehicles volumes could get a leg-up if the scrappage policy for old vehicles kicks in. The recent increase in vehicle production target for FY2020 by Maruti Suzuki, the country’s largest car-maker, is a positive indicator. These factors should help lubricant makers including Gulf Oil.

The threat from the advent of electric vehicles to the transportation, fuel and lubricants markets in India may take some years to materialise.

For quite some time now, Gulf Oil Lubricants has been consistently growing its volumes faster than the industry and increasing its market share. In the June 2019 quarter, the company’s overall volumes grew about 7.5 per cent y-o-y, compared with the flat growth for the industry.

In the September 2019 quarter, while the company’s volume growth was down about 6 per cent y-o-y, it was flat when adjusted for a one-time institutional order in the year-ago period. The overall industry volume growth was down 5-6 per cent y-o-y in the recent September quarter.

Widening of the distribution network, brand- building initiatives and product launches have helped Gulf Oil stay ahead of the competition. In the half-year ended September 2019, the company added 9-10 per cent more distributors, and the overall retail touch points were more than 73,000 as of September-end.

The number of rural stockists also increased strongly, growing to more than 900 as of September-end from around 700 six months ago.

The push towards expanding the distribution network and widening of the product range should help Gulf Oil maintain faster growth.

In the recent September 2019 quarter, the company’s factory- fills by auto-makers (about 10 per cent of volumes) fell about 60 per cent y-o-y, due to lower production numbers.

But the company was able to offset this by the more than 20 per cent increase in volumes in the personal mobility segment (cars and two-wheelers) and in the infrastructure and industrial businesses. Volume growth in the battery business was also healthy at more than 30 per cent. Exports also saw healthy growth.

The change in product mix, better realisations and stable raw material costs due to benign prices of base oil (a crude oil derivative), translated into higher margins for the company.

So, even as the company’s revenue in the seasonally slow September 2019 grew about 1 per cent y-o-y (5 per cent adjusting for the institutional sales in the year-ago period) to ₹421 crore, improvement in its operating margin helped the company post 11-plus per cent growth in profit before tax.

Lower taxes due to the corporate rate tax cut further boosted the bottom-line growth to about 54 per cent.

Road ahead

The company has lined up products to meet the BS-VI transition, and expects higher revenue growth from this change due to higher costs; the impact on margins will depend on the competitive dynamics in the industry.

The firm is considering to set up a plant (estimated capex of about ₹80 crore) to make batteries, which are currently being imported and sold.

The company has a strong balance-sheet with debt-to-equity under 1, and cash and bank balance of close to ₹400 crore.