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Castrol Indias Capital Reduction Proposal Could be a Neutral Event

Company Profile
CIL is a leading manufacturer of automotive and industrial lubricants in India. It is a
subsidiary of Castrol Limited UK, which has a 71.03% equity stake in the former.
Castrol Limited UK is itself a subsidiary of BP plc
CIL, from a minor oil company, with a market share of about 6% in 1991, it has grown
to become the 2nd largest lubricant company in India with a market share of around
25%.
CIL manufactures and markets a range of automotive and industrial lubricants. It
markets its automotive lubricants under two brands - Castrol and BP. The company has
leadership positions in most of the segments in which it operates including passenger car
engine oils, 4-stroke oils and muli d t gra e di l ese engine oils.
CIL has the largest manufacturing and marketing network amongst the lubricant
companies in India. The company has three manufacturing plants, including a state-ofthe-art plant in Silvassa. Its other 2 plants are located at Eastern Paharpur (Kolkatta) and
Patalganga (Maharashtra).The company reaches its consumers through a distribution
network of over 270 distributors, servicing over 91000 retail outlets.
CIL manufactures and markets a range of automotive and industrial lubricants under two
brands Castrol and BP. BP plc is the parent company and is one of the worlds leading
integrated oil and gas exploration and production operators with operations in 80
countries.
CIL Proposed Reduction on Capital
In April 2013, CIL has proposed to return half of its Rs 495 crs equity share capital in its
books to its shareholders by giving Rs 5 for every share they own, a first of its kind move
by an Indian listed company.
CIL will reduce its face value to Rs 5 (current FV Rs. 10/share) and return the
remaining Rs 5 to its shareholders and reduce the share capital. As a result of the
proposed capital reduction, the share capital of CIL will be reduced to Rs 247.28 crore
(FV Rs. 5/share).
The proposal by CIL is a novel method to return excess cash to shareholders as the
company is cash-rich and does not have any debt. As on June 30th p y y 2012, CIL had
Rs 651 crs Cash Balance and Rs 128 crs of Reserves and Surplus.

As a result of the proposed capital reduction, the companys paid-up equity capital
would decrease, from 494.561mn shares of INR 10 each, or INR 4.9456bn, to

494.561mn shares of INR 5 each, or INR 2.4728bn.


It is believed that, in the wake of the prospective transaction, the number of equity

shares outstanding, and the companys per-share earnings, would not change.
The amount payable by CIL to its shareholders would not be a taxable event. However,
in addition to the repayment, the company would have to pay a dividend distribution tax
on the amount payable, as per prevailing Indian income tax laws as such reduction of
capital is considered to be Deemed Dividend.
In the wake of the prospective transaction, the number of equity shares outstanding, and
the companys per-share earnings, would not change. The amount payable by
CASTROL.NS to its shareholders would not be a taxable event. However, in addition to
the repayment, the company would have to pay a dividend distribution tax on the
amount

payable,

as

per

prevailing

Indian

income

tax

laws.

The stock opened at Rs 313 and touched a high of Rs 328 on NSE. A combined 151,135
shares have changed hands on the counter till 0954 hours against an average around
100,000 shares that were traded daily in past two weeks on NSE and BSE.
Rationale for reducing Capital
CIL has provided the following rationale for its planned reduction of capital: The
capital reduction would benefit all parties uniformly.
Even after the reduction, the company would continue to have a strong balance sheet.
The capital reduction would help shareholders invest funds in other better-yielding
securities, thereby maximizing returns, as compared to the companys investments in
treasury securities, which yielded a pre-tax return of 9.17% until Dec 2012.
The capital reduction would not affect the companys ability to fund its future growth
plans, as CIL would continue continue to have a strong balance balance sheet with
surplus surplus cash.
Recommendation
We believe that there will be no negative impact on the company with respect to the
reduction in capital as the companys business is not very capital intensive and neither
does the company have any huge expansion plans in the near future, also the company

has surplus cash balance and reserves, with no debt obligation making CILs balance
sheet very strong.
The company has robust financial performance and has consistently been declaring huge
dividends above 100%, thereby benefitting all its shareholders as the company is
growing year on year.
The company is expected to reach a bottomline of ~Rs. 530 crs for the year ended FY13,
the forward EPS being ~Rs 11/share and is trading at a forward P/E of 28x We would
Castrol India Ltd. Castrol India Ltd. NVS Research Research forward EPS being Rs.
11/share and is trading at a forward P/E of 28x. We would recommend all our investors
to Accumulate CIL at levels of 270-285/ share with a 1 year Target Price of Rs.
350/share.
Precedent Transactions
Colgate-Palmolive India Ltd. (COLPAL.NS), a leading consumer sector multi-national
corporation (MNC) in India, effected a similar capital reduction plan in 2007, wherein the face
value of its equity shares was reduced from INR 10 per share to INR 1. The companys shares
outstanding, and its per-share earnings, remained the same.
Although Colgate-Palmolive India has delivered market-beating stock-price returns since 2007,
we attribute those strong returns to superlative financial performance. In other words, we do not
believe the reduction in capital itself produced significant gains for shareholders.
Our View
Inasmuch as its reduction in capital is expected to be earnings neutral, Castrol India Ltd.s stock
price performance will likely continue to be driven by business fundamentals. Moreover, we
view the stated rationale for the capital reduction proposal by Castrol India as somewhat unclear
for the following reasons:
A year ago, the company made a 1:1 bonus issue (i.e., one free share for every share held
in the company), doubling its then-paid-up equity capital. The recently proposed
transaction would reduce equity capital by 50%, effectively bringing it back to the yearago level.
One of the companys justifications for the proposal is that its surplus funds are yielding a
return of only 9.17 percent, such that shareholders would be able to achieve better returns

elsewhere. However, notwithstanding the low returns available on surplus funds, the
company generated a solid 68.9 percent return on equity (ROE) in 2012.
Castrol Indias Ltd.s outstanding share count would not change, and there would be no
impact on EPS. Also, the amount of funds being returned to shareowners would not be
material relative to the companys stock market capitalization.
Castrol India Ltd.'s fundamental results have recently improved. The company reported a
7 percent decline in post-tax profit for 2012, in spite of having attained only 4.2 percent
growth in revenues. However, during the first half of 2013, the company experienced a
14 percent increase in after-tax profit on flattish revenues.

Source: www.economictimes.indiatimes.com
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