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Visit us at www.sharekhan.com November 28, 2014

Gulf Oil Lubricants View: Positive

Melting crude puts it in a sweet spot CMP: Rs460

Key points

Falling input cost to boost earnings as well as our confidence in GOL:During the first week of September

2014, we had initiated soft coverage on Gulf Oil Lubricants (GOL) with a positive view in the Viewpoint report

titled Re-structuring to lead re-rating in line with peers in which we had talked of a healthy earnings growth

of about 17% (supported by incremental capacity and falling crude prices) and a re-rating post-demerger from

the parent company. Since then the stock has appreciated sharply fuelled by a sharp fall in global crude oil

prices as base oil (a derivative of crude oil) is the key raw material for the company. The fall in the crude oil

prices has been much sharper than our and the Streets expectations. Hence, we have tried to work out thepotential impact of the falling crude oil prices on GOLs earnings and re-examine our stance on the stock. We

believe that the softening of crude oil prices over a period of six to nine months will boost the earnings and

margin of GOL in H2FY2015 as well as our conviction in the stock.

Crude oil is down by about 30%; likely to remain weak in near term: The Brent crude oil prices have melted

down by around 30% in the last one quarter to $75 per barrel. The global oil prices had already been softening

because of higher supply (US shale and fracking induced crude oil production is at a 27-year high); now the

Organisation of Petroleum Exporting Countries (OPEC)s decision to maintain the current production of 30 million

barrels a day brings fresh weakness in the commodity. Historically, production cuts by OPEC halted the fall in crude

oil prices but in view of the recent decision of the OPEC the global crude oil prices are expected to remain weak for

a couple of months at least. Besides, the supply improvement in the USA because of the Shale technology is afundamental change that will not be reversed anytime soon.

GOL could retain some benefit; fair chance of earnings revision: Historically, prices of base oil moved with a

0.9x correlation with crude oil prices; hence we expect the price of base oil (input for GOL) to fall sharply, though

with some lag. Consequently, we expect the margin and earnings of GOL to improve in H2FY2015. However, we

dont rule out that the event could trigger a price cut among its peers (the other lubricant players) due to their

attempt to pass on some of the benefits to customers. Nevertheless, we believe that by virtue of selling branded

products and not commodity oil, lubricant companies are well placed to retain part of the benefit at their end.

Moreover, given the overall improving macro environment in India which indicates a demand recovery in the

consumer industry (automobiles), there are chances that these companies would not go for a sharp cut in prices

and would prefer to retain some benefit.

Positive stance retained: We have run a scenario analysis to understand the impact of the event on the earnings

of GOL in case it cut prices and passes on the benefit partially to the customer. As per our likely scenarios, the

earnings per share (EPS) of GOL could vary between Rs24 and Rs29 in FY2016. Given the potential earnings growth

of above 20% in the next two to three years and a sustainable hefty return on equity of 40%, the price/earnings (PE)

multiple of 20x looks justified for GOL. Moreover, post-demerger there is a re-rating lever for the stock as now it is

a pure play on the lubricant space where the benchmark leader (Castrol India) trades at a PE of ~35x. Hence, we

expect the stock to deliver returns of another 15% or so from the current level and remain positive on the stock

despite the recent run-up in its price.

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Viewpoint November 28, 20142

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sharekhan Viewpoint

Scenario analysis

We have analysed four scenarios, given the crude oil prices

are going to remain low for another six to nine months.

The first scenario is where the company will retain all

the benefit and not take any price cut, while in the second

scenario around 50% of the benefit would be passed on to

the customer through a price cut. The third and fourthscenarios have been built with an assumption of passing

of the benefit by 75% and 100% respectively through a cut

in lubricant prices. In keeping with these scenarios, we

have also come up with matching forecasts for GOLs EPS

in FY2015 and FY2016. We believe scenarios II and III are

likely, hence the EPS of GOL could vary between Rs24 and

Rs29 in FY2016.

Scenario/ EPS

Particulars FY15E FY16E

Scenario-I: No benefit passed 35 40

Scenario-II: 50% benefit passed 25 29

Scenario-III: 75% benefit passed 21 24

Scenario-IV: 100% benefit passed 16 19

Price target potential band

PE (x) Price target

Scenario I Scenario II Scenario III Scenario IV

15 600.12 439.25 358.81 278.38

17 680.13 497.82 406.66 315.50

20 800.16 585.67 478.42 371.17

22 880.17 644.23 526.26 408.29

25 1,000.20 732.08 598.02 463.97

Given the most likely EPS band of Rs24-29, we have tried

to forecast a potential price target for the stock based

on a range of PE multiples. We believe the company is

expected to deliver an earnings growth of above 20% in

the next two to three years and enjoys a sustainable return

on equity of 40% which will justify more than 20x PE

multiple for the company. Moreover, GOL is now a pureplay on the lubricant industry as it has been demerged

from the parent company, Gulf Oil Corporation, in July

2014. The demerger will continue to be the key re-rating

trigger for the stock, in line with its peers in the lubricant

industry. Though the valuation of Castrol India will remain

at a premium to that of GOL, being the market leader

and because of a higher RoE of 80%, the gap between the

valuations of GOL and Castrol India will narrow down

further. Therefore, a PE multiple of 20+ looks justified

for GOL and the potential price target could range

between Rs500 and Rs550, assuming that crude oil prices

shall remain soft over the medium term.

Viewpositive stance retained; Hold and ride the gain

The stock price of GOL has appreciated by around 45% since

our Viewpoint report; still we believe there is enough steam

left in the stock, as fundamentally crude is standing on

weak grounds which could be the biggest earnings booster

even if the company passes on part of the benefit to the

customer in response to a price cut by its competitors.

Apparently, the concern over the supply of crude oil is not

going to ease soon as the shift to shale-based production is

a fundamental change. Therefore, we believe the companyis in a sweet spot which will reflect on its margin and

earnings in the next couple of quarters. We remain positive

on the stock despite the recent run-up in its price.

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