August 8, 218, FAIR VALUE: 7 CURRENT PRICE: 9.5 Chevron Lubricants Lanka PLC (LLUB.N) Price target Current Price 52-week range Market capitalization Public float Average daily turnover YTD Performance ASPI Sector LLUB LKR 7 LKR 9.5 LKR74.8-172. LKR 21.7bn 49% LKR 14.5m -4.5% -19.5% -24.3% Depressed earnings due to competition and sluggish market Chevron Lubricants Lanka (LLUB) is the market leader in the Sri Lankan lubricants market. Nevertheless, LLUB has seen its market share fall progressively since full liberalization of the industry in 26 from a near monopoly to c.4% in 217. LLUB is particularly strong in the automobile lubricants market, thanks to its entrenched market presence, strong branding and established distribution network. We expect LLUB s volumes to broadly track industry growth which we believe will remain in low single digits over the FY18-21 period. With limited headroom for price increases, we expect LLUB s margins to erode as increasing competition limits ability to pass down cost or FX escalation. We expect LLUB s EBITDA margin to average at c.27-28% in the FY18-21 period with earning expected to decline c.3%. At 9.8x FY18 PE and 9.5x FY19 PE cf. justified PE of 5x we believe LLUB is expensive. Our 12-month DCF based target price is LKR7/share. We recommend SELL. Year End 31-Dec FY16 FY17 FY18e FY19e EPS (LKR) 14.5 1.7 9.2 9.5 DPS (LKR) 17.5 12.3 8.3 8.5 NAVPS (LKR) 16.1 16.7 17.6 18.6 P/E (x) 6.2 8.4 9.8 9.5 P/BV 5.6 5.4 5.1 4.8 Div. Yield (%) 19.4 13.6 9.2 9.5 Div. Payout (%) 12.6 114.6 9. 9. ROE (%) 81.5 65.2 53.8 52.4 Gross Margin (%) 46.9 42.9 4.7 41.3 EBITDA margin (%) 38.6 32.3 29.7 28.2 LLUB: 52 week price/volume chart 185 3,, 165 2,5, 145 2,, 125 1,5, 15 1,, 85 5, 65 7/8/218 6/8/218 5/8/218 4/8/218 3/8/218 2/8/218 1/8/218 12/8/217 11/8/217 1/8/217 9/8/217 8/8/217 7/8/217 6/8/217 5/8/217 Source: CSE, Taprobane Research Volume Price(Rs.) Lubricant market is mature; growth to remain sluggish: The lubricants market in Sri Lanka is a highly competitive, mature market with limited growth opportunities in the near term. Increase in vehicle imports and use of thermal power generation both of which are highly unpredictable have been the main drivers of volumes. With adverse macroeconomic conditions, we expect vehicle imports to be affected in the near term. The Sri Lankan Government s move to use more clean energy should lead to reduced dependence on thermal power generation. Margin and volume pressure from increased competition and FX woes: We believe LLUB will face stiffer competition from competitors looking to increase market share. The proposed issue of new lubricant blending and distribution licenses should only increase competition in an already crowded market. LLUB has seen its market share erode to c.4% in 217 from c.45% in 216. We believe this will induce more price-based competition and would likely see a drop in LLUB s volumes and margins. Moreover, LLUB has limited ability to pass down input cost and FX escalation in a crowded market. We expect LLUB s EBITDA margins to erode to c.27% over our forecast period. Steep valuation does not justify accumulation: LLUB is trading at 9.8x FY18 P/E and 9.5x FY19 P/E which we believe is expensive cf. justified PE of 5x. While we believe that LLUB will maintain its traditionally high dividend payout ratio, the amount paid as dividends would decrease in line with the expected drop in earnings. Our 12-month DCF based target price is LKR7/share. We recommend SELL. YE 31 Dec (LKR mn) FY16 FY17 FY18e FY19e FY2e FY21e Revenue 12,89 11,52 1,823 11,593 11,826 12,183 Net Profit 3,481 2,565 2,215 2,274 2,317 2,31 EPS (LKR) 14.5 1.7 9.2 9.5 9.7 9.6 +/- %YoY 12.7 (26.3) (13.7) 2.6 1.9 (.3) PER (X) 6.2 8.4 9.8 9.5 9.3 9.4 DPS (LKR.) 18 12 8 9 9 9 DY (%) 19.4 13.6 9.2 9.5 9.7 9.6 EBITDA 4,666 3,567 3,213 3,274 3,336 3,315 +/- %YoY 8.9 (23.6) (9.9) 1.9 1.9 (.6) Source: Company Data, Taprobane Research
Industry Outlook 7, 6, 5, 4, 3, 2, 1, Lubricant industry - Volumes and Sales 29 21 211 212 213 214 215 216 217 Total lubricant volumes (KLs) Total lubricant sales (Rs m) 3, 25, 2, 15, 1, 5, The Sri Lankan lubricant market is a highly competitive, mature market. At present, the market has 14 players with Lanka IOC (Servo), Laugfs Lubricants and LLUB being the only domestic manufacturers. In addition, the Ceylon Petroleum Corporation (CPC) has entered into a Build-Operate-Transfer (BOT) project with Hyrax Oil SDN BHD of Malaysia to locally blend and distribute lubricants. The bulk of lubricant sales volumes comes from the automobile segment (more than 72%) followed by industrial (c.17%) and marine (c.6%) segments. The lubricant market is officially regulated by the Ministry of Petroleum Resources. Whilst plans are afoot to further liberalise the industry, the enabling legislations are yet to come into force. In line with the Government policy of liberalizing all utility services, the lubricants market was also expected to be placed under the purview of the Public Utilities Commission of Sri Lanka (PUCSL). Nevertheless, the relevant legislations are yet to be enacted. As such, the PUCSL functions as a shadow regulator, under a decision of the Cabinet of Ministers The Government is reportedly considering another round of licensing with up to 4-5 licenses supposedly on offer. While lubricant blending requires little capex, the biggest barrier to market entry is regulatory restrictions, whereby licensing is issued only on a periodical basis. The last round of licensing was called in 213, only to be abruptly cancelled. Another barrier to entry is that Lubricant licenses are issued specific to the brand and cannot be easily transferred, even with the acquisition of the company marketing or manufacturing the said brand. LLUB - Revenue and Sales Volumes 4, 35, 3, 25, 2, 15, 1, 5, 21 211 212 213 214 215 216 217 LLUB - sales volumes (KLs) LLUB Revenue (Rs m) 14 12 1 8 6 4 2 Company Overview Chevron Lubricants Lanka (LLUB), is the market leader of the Sri Lankan lubricant market with a share of c.4%. It blends and distributes, lubricants and greases under Delo, Lanka, Havoline and Caltex brands. The automotive sector contributes c.7% of revenue with the rest from the industrial segment. The industrial segment comprises mostly of diesel power plants and the state-run railways and the public bus transportation service. LLUB also exports to Bangladesh and the Maldives. LLUB was created by the spin-off of the lubricating oil blending plant of the stateowned Ceylon Petroleum Corporation (CPC) in 1992. The company was privatized in 1994 with Caltex purchasing a 51% stake. LLUB enjoyed a monopoly on local manufacture and distribution of lubricants through CPC owned and managed service stations till 24. LLUB has an extensive distribution channel serving the retail automobile lubricants market. This is primarily through service stations (both independent service stations and co-branded service centres). LLUB s products are also marketed at Caltex Oil Marts and selected filling stations.
2-Dec-16 2-Jan-17 2-Feb-17 2-Mar-17 2-Apr-17 2-May-17 2-Jun-17 2-Jul-17 2-Aug-17 2-Sep-17 2-Oct-17 2-Nov-17 2-Dec-17 2-Jan-18 2-Feb-18 2-Mar-18 2-Apr-18 2-May-18 2-Jun-18 2-Jul-18 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 Coverage Initiation 5, 45, 4, 35, 3, 25, 2, 15, 1, 5, Automobile Lubricant sales volumes 21 211 212 213 214 215 216 217 Automobile lubricants volumes (KLs) Vehicle registrations 8, 7, 6, 5, 4, 3, 2, 1, Automotive lubricant usage is dependent on vehicle import policy: Automotive lubricants account for c.72% of the Sri Lankan lubricant market. LLUB s topline is also reflective of this trend. Price based competition is prevalent in the B2B (drum sales) segment, while in the B2C (retail pack sales) segment, branding and distribution channel strength are important factors. The increased focus on ecofriendly, fuel efficient passenger vehicles with extended oil drain cycles as well as electric vehicles which require substantially less servicing should see volumes stagnate in the automobile segment. While increased focus on logistics and road and rail based passenger transportation should see some volume growth, we feel that this would only see a modest increase over the near term. Source: PUCSL, CBSL, Taprobane Research annual increase in thermal generation (YoY%) 12% 1% 8% 6% 4% 2% % -2% -4% -6% Thermal power is a key driver of demand: Drought induced thermal power generation is a key driver of lubricant volumes. Diesel generators used in thermal power generation consume significantly more lubricants than hydro or coal power plants. With the Sri Lankan Government s drive towards cleaner energy such as solar and wind power, lubricant usage in the electricity generation sector should remain stagnant unless in the case of urgent requirement for thermal power (either weather induced or as a requirement to fulfil short term generation lapses). Intense competition provides limited ability for price increase: LLUB has very limited scope for passing down raw material or FX cost escalation to its customers, given the intensely competitive nature of the business. This will naturally impact its margins and earnings. With base oil prices showing an upward price revision and LKR depreciation, we expect LLUB to face margin pressure from the inability to fully pass down cost escalations over the near term. 1 8 6 4 2 Base oil prices Group I& II - FOB Asia LKR depreciation is a concern: LLUB s raw materials (Base oils and additives) are almost entirely sourced from overseas. Its topline to a large extent (c.9%) is dependent of LKR denominated local sales. This along with the limited scope to increase price by passing down FX related costs should put a dent on LLUB s earnings over our forecast period with LKR expected to depreciate by c.6-7% annually. Group I SN15-FOB Asia Group I SN5-FOB Asia Group II SN15-FOB Asia Group II SN5/6-FOB Asia Source: Lube Report Asia, Taprobane Research Base oil prices should continue to rise gradually in FY18-2 period: Asian Group I and Group II Base oil prices have increased by more than c.25% across all grades of base oils. LLUB uses Group I and Group II base oil and does not plan to shift to higher grade oils. While historically base oil prices lagged crude oil prices, this trend has shortened in recent months. We expected base oil prices to increase in the FY18-2 period. Again, we are concerned over LLUB s ability to pass a major portion of base oil price increase to customers given the prevailing market conditions. Counterfeit products have affected the industry: The market for counterfeited lubricants has continued to be a problem for the players representing global lubricant brands. While there are no official estimates, the size of the grey market has been tagged at c.1-15% of the official market. The PUCSL has conducted raids to curb the grey market, but lack of enabling legislations has hampered this effort.
4,5 4, 3,5 3, 2,5 2, 1,5 1, 5 Source: PUCSL, CBSL, Taprobane Research 5 45 4 35 3 25 2 15 1 5 Marine Lubricant sales volumes 21 211 212 213 214 215 216 217 Marine lubricants volumes (KLs) Vessel arrivals ARPU - Lubricant industry vs. LLUB 29 21 211 212 213 214 215 216 217 Industry (Ex. LLUB) ARPU (Rs.) LLUB ARPU (Rs.) 6, 5, 4, 3, 2, 1, The Bangladesh lubricant market is a growth opportunity for LLUB: The Bangladesh lubricant market is estimated at c.1m litres per annum with the grey market estimated to be c.6% of the total market. It is estimated that five players Mobil, Bangladesh Petroleum, Total, Shell and Castrol together account for c.63% of the market. Automobile lubricants account for c.75% of the Bangladesh lubricant market with the rest made up by the industrial segment. As the Bangladeshi market grows, we expect LLUB to benefit given the brand advantage of Chevron. Currently the Chevron brand has a c.2% market share. LLUB s export revenue grew c.12% YoY in FY17 to LKR1.1bn (c.1% of revenue). Change in top management should bring new strategy: With recent changes in LLUB s senior management, we feel that LLUB has an opportunity to explore alternative strategies for growth and profitability. While the adverse macroeconomic and local lubricant market conditions pose severe challenges, LLUB can now re-think its pricing and market share strategy. While LLUB s ARPU has on average been higher than the industry, this gap has declined in recent years. LLUB has also stated that its majority shareholder, Chevron, has no immediate plans to divest its stake in LLUB. Marine lubricants segment has potential for growth: With Sri Lanka positioning itself as a maritime hub, we see growth potential in the marine lubricants market. Currently this market accounts for c.6-7% of total lubricant volumes. With the Colombo port traditionally being a convenient bunkering port, lubricant services too can be provided, especially at the outer port limit (OPL). Nevertheless, this requires specialised vessels used to transport lubricants to ships anchored in the open sea. Sino-US trade war could see increased additives and lubricant production in the Asian region: With the US being a net exporter of lubricants and related products to China, US firms may choose to establish plants in the Asian region to circumvent higher tariffs in China. Additionally, Asian lubricant producers may ramp up production to meet any supply shortfall in the Chinese market. Nevertheless, it is too early to predict what impact this may have on prices. Valuation is expensive: We expect LLUB s earnings to gradually decrease by c.3% on the back of lower volumes and weak pricing. Nevertheless, we believe that LLUB will maintain its traditionally high dividend payout ratio. Compared to a justified PE of 5x, LLUB is trading at 9.8x FY18 P/E and 9.5x FY19 P/E and in our view is expensive. While LLUB has traditionally been viewed as a dividend play, the amount paid as dividends should moderate in line with the expected slowdown in earnings. Our 12-month DCF based target price is LKR7/share (Ke -17.5%, g - %). We recommend SELL.
Income statement summary (LKR m) Y/e 31 Dec FY15 FY16 FY17 FY18e FY19e FY2e FY21e Revenue 11,564 12,89 11,52 1,823 11,593 11,826 12,183 Gross Profit 5,196 5,671 4,741 4,41 4,786 4,341 4,337 EBITDA 4,286 4,666 3,567 3,213 3,274 3,336 3,315 EBIT 4,143 4,515 3,46 3,6 3,125 3,188 3,17 Interest (expense)/ income 175 187 9 16 33 3 39 Profit before tax 4,319 4,73 3,496 3,76 3,158 3,218 3,28 Taxes (1,231) (1,221) (931) (861) (884) (91) (898) NPAT 3,88 3,481 2,565 2,215 2,274 2,317 2,31 Cashflow summary (LKR m) Y/e 31 Dec FY15 FY16 FY17 FY18e FY19e FY2e FY21e Profit Before Tax 4,319 4,73 3,496 3,76 3,158 3,218 3,28 Cash From Operating Activities 3,184 3,862 1,446 2,698 2,234 2,348 2,324 Cash From Investing Activities (95) (91) (92) (18) (116) (118) (122) Cash from Financing Activities (2,4) (4,2) (3,24) (1,993) (2,46) (2,85) (2,79) Net Changes in Cash 1,49 (429) (1,886) 597 72 144 124 Free Cash Flow 3,89 3,771 1,354 2,59 2,118 2,229 2,23 Free Cash Flow per Basic Share 13 16 6 11 9 9 9 Operating Cashflow per Share 13 16 6 11 9 1 1 Balance sheet summary (LKR m) Y/e 31 Dec FY15 FY16 FY17 FY18e FY19e FY2e FY21e Property, Plant & Equipment 2,196 2,133 2,67 2,23 1,989 1,96 1,936 Total Current Assets 4,759 4,839 3,452 4,133 4,428 4,77 4,992 Total Assets 7,45 7,47 5,596 6,232 6,494 6,744 7,5 Total Current Liabilities 2,59 2,82 1,181 1,711 1,745 1,764 1,793 Total Long-Term Liabilities 33 366 48 48 48 48 48 Shares Outstanding * 24 24 24 24 24 24 24 Book Value per Share 2 16 17 18 19 2 2 Total Liabilities & Equities 7,45 7,47 5,596 6,232 6,494 6,744 7,5 * adjusted for share split Ratio analysis Y/e 31 Dec FY15 FY16 FY17 FY18e FY19e FY2e FY21e Revenue growth (%).4 4.5 (8.6) (2.1) 7.1 2. 3. EBITDA growth (%) 18.5 8.9 (23.6) (9.9) 1.9 1.9 (.6) Gross margin (%) 44.9 46.9 42.9 4.7 41.3 36.7 35.6 EBITDA margin (%) 37.1 38.6 32.3 29.7 28.2 28.2 27.2 Net profit margin (%) 26.7 28.8 23.2 2.5 19.6 19.6 19. Return on equity (%) 62.5 81.5 65.2 53.8 52.4 5.7 48.1 Source: Company Data, Taprobane Research
Sales Team Niranjan Niles Chief Executive Officer niles@taprobane.lk +94 11 532816 Mahesh Pieris Director - Institutional Sales mahesh@taprobane.lk +94 11 5328155 Romesh Kenny Manager - Institutional Sales romesh@taprobane.lk +94 11 5328166 B.L.A. Dayananda Assistant Manager dayananda@taprobane.lk +94 11 5328168 Gayan Silva Assistant Manager - Retail Sales gayan@taprobane.lk +94 11 532817 Malka Ranaweera Investment Advisor malka@taprobane.lk +94 11 5328156 Pasindu Yatawara investment advisor pasindu@taprobane.lk +94 11 532814 Chinthaka Weerarathna Investment Advisor chinthaka@taprobane.lk +94 11 5328112 Research Abdul Hafeel Senior Reseach Analyst hafeel@taprobane.lk +94 11 5328193 Disclaimer The report has been prepared by Taprobane Securities (Private) Limited. The information and opinions contained herein have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such information has not been independently verified and no guaranty, representation or warranty, express or implied is made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document is for information purposes only, descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an offer, to buy or sell any securities or other financial instruments.