Chevron Lanka Lubricants PlcRecommendation : SELL

Can ‘FRICTION’ be controlled?

University of Moratuwa Team B CFA Sri Lanka Challenge : Financial Analyst Competition 2009

Company Background

• Holds the largest market share of 70%

• Chevron is a manufacturer of lubricants, and presently is only involved in the lube industry.

• Main revenue segments include automotive and commercial and industrial (C&I) segment

• Part of revenue is from export markets (10%), but mostly from domestic sales

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Investment View Current Price (as at Sep 30th) : LKR 151Target Price ( 12 month) : LKR 124

The share is overvaluedRecommendation : SELL

Investment Arguments: • Volumes in the Automotive and C&I Segments.

• Rising Raw Material Costs.

• Increased Competition.

• Threat on the distribution channel.

• Product Shift from Lanka to Caltex.

• Finance Income

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Automotive and C&I Segments  

Lubricant Industry & Product Segmentation

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Automotive Lubricants Downturn growth

• High tariffs on imported vehicles

• Limited provision of leases by financialinstitutions

•The increase in fuel prices

• Vehicle maintenance cost which has doubled over the past 5 years

• The ban on the import of 2T three-wheelers and spare parts

• Car pooling – environmental issues, to reduce traffic congestion, high costof living

• Widening of oil drain intervals due to market education by firms such asChevron

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C&I Lubricants : Emerging opportunities

• In 2008 and early 2009 the lube consumption from the defense forces has seen adrastic increase of 45 - 47%. With the conclusion of the war a further increase cannotbe expected.

• Supply for the C&I segment is mainly through tender agreements, and we believethat it is possible for Chevron to tap into these emerging prospects. However thegovernment arm CPC entering the market can influence the winning of these tenders.

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Rising Raw Material Costs 

Rising Base Oil & Additive pricesBase Oil:• Base oil prices follow the same trend as crude oil with a certain time lag.

• The global long term annual average growth rate for crude oil is approximately 3.5%

• Ignoring unanticipated movements, this trend is most likely to follow in to the future.

• Base oil suppliers high bargaining power

Additives :The global annual expected growth rate is around 1%

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Impact on Cost of Sales

• Rise in raw material cost will be approximately 3.5%. • Inventory will grow.• This increases in costs are expected to be passed onto the consumer.

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Increased Competition and Threat on the Distribution Channel

Increased Competition

• The present Sri Lankan lubricant industry 16 players.

• It is an oligopoly with Chevron being the price leader.• LIOC is the main competitor of Chevron , and being the only two lube

manufacturers enjoying the same tariff advantage.

• Could Chevron retain its market share?

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Reasons Behind the competition

• The issuing of licenses is controlled by the government with any participant meeting the criteria, allowed to enter the industry.

• LIOC is a growing threat due to the potential expansion in it’s distribution points.

• CPC holds the other distribution avenue which targets the automotive segment, and Laugfs has a legal right to this channel.

• These combined effects will result in Chevron loosing their market share.

Low Barriers to Entry  Rivalry Distribution

Price

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CPC Distribution Channel – Not anymore?

• Availability is the key factor for automotive sector lube sales.• Filling stations are the main stream of retail sales.• CPC filling stations are Chevron’s main distribution channel.

• 88% of filling stations are CPC owned.• 80% of automotive sales HDEO and 2T/4T oils which are sold

through filling stations.• A disruption of access to the CPC channel will result in a significant drop

in Chevron’s volumes.

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Product Shift from Lanka to Caltex

Product shift

Chevron’s Strategy

What would a cost conscious consumer do?

• HEDO & 2T/4TLess brand consciousMore price sensitive80% of Automotive demand50% of Total demand

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Possibility

Impact on the Operating profit of Chevron

Operating Profit per unit Volume

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Impact on the Operating Profit per unit?

• Sales prices

• Cost of sales

Minor increase inOperating Profit per unit

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Customers’ shift to High priced lubes?

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Customers’ shift to High priced lubes?

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Reduction In Volumes

• Low brand conscious customers

• Price sensitive customers

• Go for the low price products – Not Caltex 

Decrease in Sales volumes

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Impact on the Operating Profit

Decrease in Sales volumes

Minor increase inOperating Profit per unit

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Finance Income 

Finance Income

• Approximately 7.38% of operating profit in 2008

•The treasury bill rate is on a decreasing trend due to external borrowings and likely to continue in the short run

• However, after the effects of the borrowings we expect that it will pick up on a natural rate in the long run

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Financial Impact and Valuation 

Financial Forecasts5 year CAGR Levels for the forecast period:

Revenue : 2.29%

Net Income : 3.13%

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Valuation – DCF Target Price ( 12 month) : LKR 124Optimistic (Ke=8.58 %) : LKR 215Pessimistic (Ke=20.58 %) : LKR 89

SELL

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Thank You ! 

Potential Questions• Revenue Growth• Volume Change Expectations ‐ Automobile and C&I segments• Sri Lankan Stock Market• Effect of Grey market• Export market and impact from North & East• Stake of Service stations and retail outlets• Are consumers Brand Conscious or not?• Does LIOC and Laugfs have Limited Distribution?• Dividend Valuation Model• Target price in the current interest rate scenario • Financial Ratios• Working Capital Ratios 

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Revenue GrowthRevenue growth is mostly attributable to the rising product prices rather than volume changes.

Even though revenue is growing in absolute terms, it is not to the extent that has been shown in the past few years.

The growth in 2011 is due to our belief that the industrial sector should pick up by then.

Thereafter with increased competition Chevron’s revenue will settle at a terminal growth rate.

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Volume Change Expectations ‐ Automobile and C&I segments

Automobile Segment:With the continuation of higher tariffs on vehicle imports, rising fuel prices and maintenance costs the growth based on volumes is limited.

The high competition is mostly on this segment, impacting Chevron’s volumes.

C & I Segment :There will be industrial growth and Chevron will gain a share of this due to its dominant position in this segment.

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Sri Lankan Stock MarketCompared to the levels of the ASPI at the beginning of 2009 we can see a drastic increase since the middle of the year, due to over expectations of investors on the higher level of economic growth in the country.

This has created a demand and supply imbalance driving up the stocks in the market.

This phenomena can be seen in the price movement of Chevron as well.

We believe that based on our financial model from a fundamental point of view the share value of Chevron’s share is LKR 124.

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Export Market

Impact on sales from the North & East

• Approximately 10% of Total Revenue

• YOY growth during 2008 :

• Bangladesh – 80% Not sustainable

• Maldives - 20% Marginal room for growth

• Chevron already operates in this area

• Probable expansion in agricultural and fisheries sector

• Slight positive impact on C&I sector

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Effect of Grey market• Grey market products are mostly available for greases.

• The oil consumer is more conscious about using a ‘particular brand'. Therefore there is a limitation for grey market with regard to lube oil.

• However if some legal actions are not in place, there is potential growth in the grey market.

• Established brands will be affected (E.g. Caltex)

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Stake of Service stations & Retail outlets

• These two channels only account for nearly 20% of the total distribution of Automotive lubes.

• At present the main distribution is through filling stations.

• The above two avenues are the main selling points for the premium brand Caltex, in order to reach the brand conscious consumer.

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Are consumers Brand Conscious or not?

• A limited group of the automobile segment is brand conscious.

• However the largest consumer segment of this sector is price conscious, which is the commercial vehicle users, heavy diesel and three wheelers/bikes.

• Therefore the higher impact on volumes is through the cost conscious consumer.

• The C&I segment is mostly concerned of the ability to meet the wide range of lubricant requirements.

Luxury vehicle user

Normal passenger Car user

HDEO & 2T/4T

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Does LIOC and Laugfs have Limited Distribution?

• LIOC is an expanding competitor

o Many CPC filling stations are taken over by LIOC

o New filling stations

o Emerging out of city suburbs

• Laugfs gained legal permission to sell through CPC filling stations

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Dividend Valuation Model• The DCF valuation was conducted using a dividend payout ratio of 70%

Target price (12 month) LKR 107

• If a large dividend were declared to reduce the cash balance, considering a maximum of Rs 34 (dividend for 2009)

Target price (12 month) LKR 128

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Target price in the current interest rate scenario 

The present decline in rates could be a temporary effect.

It is due to government intervention rather than supply and demand principles.

Whether it is sustainable is a question.

Since this is an arbitrary phenomenon, our 12 month forecast rate uses the most realistic possibility to arrive at the target price.

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Financial Ratios 

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Working Capital Ratios 

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