Castrol reported in-line Q3CY10 results with its net income at Rs 1.17 bn versus our estimate of Rs 1.11 bn. The lower-than expected volumes were compensated by higher-than expected realisations as the company effected a 4% hike in prices in July 2010. We maintain Sell rating on Castrol noting the stock is trading at 23.1x (times) calendar year 2011 EPS (earnings per share) and 28% above our 12-month target price of Rs 390.

Castrol reported Q3CY10 net income at Rs 1.17 bn (-22.2% QoQ, +22.3% YoY). The modest positive variance despite lower-than-expected volumes was due to (i) higher-than-expected realisation resulting from a 4% price hike effected in July 2010 and (ii) lower-than-expected advertisement costs. Revenues increased to Rs 6.4 bn (+13.5% YoY) led by higher realisation at Rs 127.3/litre versus Rs 111.8/litre in Q3CY09. Castrol?s volumes declined 0.4% YoY to 50.5 m litres versus 50.7 m litres in Q3CY09. Castrol?s 3QCY10 Ebitda (earnings before interest, taxes, depreciation and amortisation) margin was at 26.4% versus 25.4% in 3QCY09. We highlight that a QoQ comparison of results is not valid due to seasonality; Q2 and Q4 in a calendar year are the best quarters. We currently assume an Ebitda margin of 27.8% for CY2011, which is higher than Castrol?s Ebitda margin of 24.8% in CY2009 and the average Ebitda margin of 16.4% over CY2001-08.

We note that our revised 12-month target price of Rs 390 (380 previously) is based on 18x CY2011 EPS. We also note that the stock has historically traded in a P/E (price-to-earnings) band of 14-18x. The current valuations reflect a situation of ascribing an all-time high multiple to peak level of earnings. We believe that the stock provides an unfavourable risk-reward balance at current levels and would advise investors to book profits and wait for better opportunities at lower levels to get back in.

We have fine-tuned our CY2010E and CY2011E EPS estimates to Rs 21 and Rs 21.7 from Rs 20.7 and Rs 21.2, respectively, to reflect (i) lower sales volumes (-ve impact), (ii) higher LOBS (lube oil base stock) prices (-ve impact), (iii) higher realisation (+ve impact), (iv) stronger rupee (+ve impact), and (v) other changes to reflect Q3CY10 results. We have revised our target price to Rs 390 from 380 previously based on 18x CY2011E EPS of 21.7. The modest upward revision in target price reflects upward revision of earnings. Castrol reported a steep 10.8% increase in unit raw material cost to Rs 66.7/litre versus Rs 60.1/litre in Q2CY10. The QoQ increase in raw material cost is in line with the increase in global LOBS prices.

Price hikes result in higher realisation QoQ. Castrol?s Q3CY10 gross realisation was higher at Rs 127.3/litre versus Rs 123.9/litre in Q2CY10 and Rs 111.8/litre in Q3CY09. The QoQ increase in realisation reflects the price hike of 4% effected by the company in July.