Financial Times

Caltex margins under pressure from competition

Caltex Lubricants Lanka, in the longer run, will not be realistically able to sustain the healthy margins enjoyed at present largely due to increased competition stemming from new rivals, Bartleet Mallory Stockbrokers said in a research report.

However, they said that despite industry rivalry expected to increase in domestic lubricant operations, Caltex could still optimize its future earnings potential given the company's strategy to focus on export markets and possible diversification.

Caltex has the wherewithal to meet such new investments using its internally generated funds.

Bartleet Mallory Stockbrokers said the company enjoys a virtual monopoly status in the lubricant industry with over 90 percent market share.

"The lubricant industry in Sri Lanka is rather stable having a moderate growth of six percent per annum. Although until recently the company benefited from its stranglehold in Sri Lanka's petroleum industry, with the liberalization efforts by the government to create a level playing field, Caltex will now need to meet the competition that was not present before."

The main competition is expected to come from the Indian Oil Company following its entry into the Sri Lanka's petroleum industry with the purchase of 100 petroleum stations from the Ceylon Petroleum Corporation (recently rebranded as Ceypetco as an initial step for its privatization programme).

"At present the company is confronted with rather modest competition from Shell, Mobil, Castrol, BP and Valvoline in the lubricant market," Bartleet Mallory said.

In a bid to further liberalize the industry by the government, the Public Enterprise Regulatory Commission (PERC) is searching for another player to have a share in the petroleum market with a further divestment of 100 petroleum stations.

At present Caltex Lubricants Lanka Ltd. has largely confined its business to manufacturing, importing, blending, distributing and exporting of lubricants.

The industrial market for lubricants, of which CEB is one of the biggest consumers, is expected to grow on the back of new thermal power plants coming up in the country.

"In this backdrop Caltex is well positioned to cater to any surge in demand of this nature supported by its excess plant capacity and ability to supply in bulk.

"The company believes that the demand for its lubricant products stemming from the automobile sector will be on the upward trend due to the fact that 80 percent of the vehicles used in Sri Lanka are about 10 years old and the subsequent high need for use of lubricants," the stock brokers said.

Caltex Lubricants Lanka Ltd. has the strategic advantage of having a tie-up with Ceypetco, where the company is entitled to use the existing pipelines and storage tanks.

"The huge investment required to set up a similar venture has prevented new direct competitors coming into the market," Bartleet Mallory said. "Even if an investor wants to commit a large investment to operate, to recover merely the investment the investor will need to capture at least a 30 percent share of the market. To gain such a market share, it will take around 8-10 years and therefore the investment cannot be simply justified."

According to Caltex Lubricants Lanka Ltd the lubricant plant in Sri Lanka is operating at 60 percent of its capacity. Therefore with the intention of increasing operating efficiency by utilizing the full plant capacity the company is hoping to expand its export business to some other countries such as Bangladesh and Mauritius.

Caltex is currently exporting its products to the Maldives.

The company is having a competitive edge over its competitors in cost management as Caltex benefits especially from economies of scale in terms of raw material purchasing with the company's association with the global energy giant, Chevron Texaco.

The parent company procures raw materials such as base oil and additives to 160 manufacturing plants scattered across the world and thus enjoys the benefits attributable to bulk purchases. These benefits are thus passed on to each and every manufacturing plant including Caltex Lubricants Lanka Ltd.

The cost of production (COP) pertaining to manufacture of lubricant consists of 70% of base oil, 10% of additives and 20% of labour and packing material. The base oil is positively correlated to global oil prices and any major fluctuation of oil prices will pose a significant impact on the COP, Bartleet Mallory Stockbrokers said.

"The financial aspects of Caltex Lanka Lubricants Ltd are the ones that investors need to be seriously aware of, as the company's financial performance and the financial position have been truly incredible.

"This facet alone has made LLUB one of the most attractive stocks in the Colombo Stock Exchange, though unfortunately the stock's strong fundamentals seem to have gone unnoticed among investors," it said.

The company is having huge short-term investments of over Rs. 1.8 billion presently, which can certainly be utilized to diversify its lubricant business in Sri Lanka to other related businesses such as petroleum and gasoline.

"LLUB is probably one of the very few quoted companies in Sri Lanka comfortably enjoying a debt-free position," Bartleet Mallory said. "The shareholders funds have seen an upward trend and are expected to rise to approx Rs. 3 Bn by the end of FY 2003."

The stock brokers forecast that the company will record a revenue growth of 10 percent amounting to Rs. 4.32 billion based on the assumption that Caltex will increase its export market share whilst continuing to be a dominant force in the domestic lubricant market.

"Based on a conservative estimate we expect the company to post a decent bottom line figure of Rs. 841 million for the year 2003, reflecting a 3.6% YoY growth.

"Our forecast EPS and PE for the stock based on the above mentioned net profit amount and a market price of R. 151/- are Rs. 28.05 and 5.38 times respectively.

Backed by high earnings, Caltex declared an attractive dividend of 123% in FY 2002 with the dividend pay out standing at 45%. With earnings expected to grow YoY in FY 2003 and assuming a similar dividend policy, the stock offers an attractive dividend yield of 8% based on current market price levels.