Coverage Initiation TAPROBANE | RESEARCH

August 8, 2018,
2018 Depressed earnings due to competition
FAIR VALUE: 70
and sluggish market
CURRENT PRICE: 90.50
Chevron Lanka Lubricants (LLUB) is the market leader in Sri Lankan lubricants
Chevron Lubricants Lanka PLC (LLUB.N000) market. Nevertheless, LLUB has seen its market share fall progressively since full
liberalization of the industry in 2006 from c.80% to c.40% in 2017. LLUB is
Price target LKR 70 particularly strong in the automobile lubricants market, thanks to its entrenched
Current Price LKR 90.5 market presence, strong branding and established distribution network. We
52-week range LKR74.8-172.0
Market capitalization LKR 21.7bn expect LLUB’s volumes to broadly track industry growth which we believe will
Public float 49% remain in low single digits for FY18-FY20 period. With limited headroom for price
Average daily turnover LKR 14.5m increases, we expect LLUB margins to erode as increasing competition limits
ability to pass down cost or FX escalation. We expect LLUB’s EBITDA margin to
YTD Performance
ASPI -4.5% average at c.27-28% in the FY18-21 period with earning expected to decline c.3%.
Sector -19.5% At 9.8x FY18 PE and 9.5x FY19 PE cf. justified PE of 5x we believe LLUB is
LLUB -24.3% expensive. Our 12-month DCF based target price is LKR70/share. We recommend
SELL.

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
Year End 31-Dec FY16 FY17 FY18e FY19e power generation both of which are highly unpredictable have been the main
EPS (LKR) 14.5 10.7 9.2 9.5 drivers of volumes. With adverse macroeconomic conditions, we expect vehicle
DPS (LKR) 17.5 12.3 8.3 8.5 imports to be affected in the near term. The proposed issue of new lubricant
NAVPS (LKR) 16.1 16.7 17.6 18.6 blending and distribution licenses should only increase competition in an already
P/E (x) 6.2 8.4 9.8 9.5 crowded market.
P/BV 5.6 5.4 5.1 4.8
Div. Yield (%) 19.4 13.6 9.2 9.5 Margin and volume pressure from increased competition and FX woes: We
Div. Payout (%) 120.6 114.6 90.0 90.0 believe LLUB will face stiffer competition from competitors looking to increase
ROE (%) 81.5 65.2 53.8 53.7 market share as the government attempts to further liberalise the lubricants
Gross Margin (%) 46.9 42.9 40.7 41.3
market. Already LLUB has seen its market share erode to c.40% in 2017 from
EBITDA margin (%) 38.6 32.3 29.7 28.2
c.45% in 2016. We believe that 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
185 3,000,000 earnings. Our 12-month DCF based target price is LKR70/share. We recommend
165 2,500,000 SELL.
145 2,000,000 YE 31 Dec (LKR mn) CY16 CY17 CY18e CY19e CY20e CY21e
125 1,500,000
Revenue 12,089 11,052 10,823 11,593 11,826 12,183
Net Profit 3,481 2,565 2,215 2,274 2,317 2,310
105 1,000,000
EPS (LKR) 14.5 10.7 9.2 9.5 9.7 9.6
85 500,000
+/- %YoY 12.7 (26.3) (13.7) (11.4) 1.9 (0.3)
65 0
PER (X) 6.2 8.4 9.8 9.5 9.3 9.4
5/8/2017

6/8/2017

7/8/2017

8/8/2017

9/8/2017

10/8/2017

11/8/2017

12/8/2017

1/8/2018

2/8/2018

3/8/2018

4/8/2018

5/8/2018

6/8/2018

7/8/2018

DPS (LKR.) 18 12 8 9 9 9
Volume Price(Rs.)
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
Source: CSE, Taprobane Research +/- %YoY 8.9 (23.6) (9.9) (8.2) 1.9 (0.6)
ROE (%) 81.5 65.2 53.8 53.7 50.7 48.1
Source: Company Data, Taprobane Research
Coverage Initiation TAPROBANE | RESEARCH

Industry Outlook

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.

Source: PUCSL, Taprobane Research 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 2013,
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

40,000 14000
Company Overview
35,000 12000
30,000
10000 Chevron Lubricants Lanka (LLUB), is the market leader of the Sri Lankan lubricant
25,000

20,000
8000 market with a share of c.40%. It blends and distributes, lubricants and greases
6000
15,000 under Delo, Lanka, Havoline and Caltex brands. The automotive sector
4000
10,000

5,000 2000
contributes c.70% of revenue with the rest from the industrial segment. The
0 0 industrial segment comprises mostly of diesel power plants and the state-run
2010 2011 2012 2013 2014 2015 2016 2017

LLUB - sales volumes (KLs) LLUB Revenue (Rs m)

railways and the public bus transportation service. LLUB also exports to
Bangladesh and the Maldives.
Source: PUCSL, Taprobane Research
LLUB was created by the spin-off of the lubricating oil blending plant of the state-
owned 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 2004.

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.
Coverage Initiation TAPROBANE | RESEARCH

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
Automobile Lubricant sales volumes
also reflective of this trend. Price based competition is prevalent in the B2B (drum
50,000 800,000
45,000 700,000 sales) segment, while in the B2C (retail pack sales) segment, branding and
40,000
600,000
35,000
500,000
distribution channel strength are important factors. The increased focus on eco-
30,000
25,000 400,000 friendly, fuel efficient passenger vehicles with extended oil drain cycles as well as
20,000 300,000
15,000
200,000
electric vehicles which require substantially less servicing should see volumes
10,000
5,000 100,000
stagnate in the automobile segment. While increased focus on logistics and road
0 0
2010 2011 2012 2013 2014 2015 2016 2017 and rail based passenger transportation should see some volume growth, we feel
Automobile lubricants volumes (KLs) Vehicle registrations
that this would only see a modest increase over the near term.
Source: PUCSL, CBSL, Taprobane Research
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
annual increase in thermal generation (YoY%) power plants. With the Sri Lankan Government’s drive towards cleaner energy
120% such as solar and wind power, lubricant usage in the electricity generation sector
100%

80%
should remain stagnant unless in the case of urgent requirement for thermal
60% power (either weather induced or as a requirement to fulfil short term generation
40%
lapses).
20%

0%
Intense competition provides limited ability for price increase: LLUB has very
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

-20%

-40%
limited scope for passing down raw material or FX cost escalation to its
-60%
customers, given the intensely competitive nature of the business. This will
Source: PUCSL, Taprobane Research 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.

Base oil prices Group I& II - FOB Asia LKR depreciation is a concern: LLUB’s raw materials (Base oils and additives) are
1000
almost entirely sourced from overseas. Its topline to a large extent (c.90%) is
800
600 dependent of LKR denominated local sales. This along with the limited scope to
400
increase price by passing down FX related costs should put a dent on LLUB’s
200
0 earnings over our forecast period with LKR expected to depreciate by c.6-7%
20-Feb-17

20-Apr-17
20-May-17

20-Sep-17

20-Feb-18

20-Apr-18
20-May-18
20-Jun-17

20-Nov-17

20-Jun-18
20-Dec-16

20-Mar-17
20-Jan-17

20-Aug-17

20-Dec-17

20-Mar-18

20-Jul-18
20-Jul-17

20-Oct-17

20-Jan-18

annually.
Group I SN150-FOB Asia Group I SN500-FOB Asia
Group II SN150-FOB Asia Group II SN500/600-FOB Asia
Base oil prices should continue to rise gradually in FY18-20 period: Asian Group I
and Group II Base oil prices have increased by more than c.25% across all grades
Source: Base oil weekly, Taprobane Research 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 FY18-20 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.10-15% of the official market. The PUCSL has conducted
raids to curb the grey market, but lack of enabling legislations has hampered this
effort.
Coverage Initiation TAPROBANE | RESEARCH

The Bangladesh lubricant market is a growth opportunity for LLUB: The

Bangladesh lubricant market is estimated at c.100m litres per annum with the
grey market estimated to be c.60% 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.
Source: PUCSL, CBSL, Taprobane Research
LLUB’s export revenue grew c.12% YoY in FY17 to LKR1.1bn (c.10% 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
ARPU - Lubricant industry vs. LLUB alternative strategies for growth and profitability. While the adverse
500
450 macroeconomic and local lubricant market conditions pose severe challenges,
400
350 LLUB can now re-think its pricing and market share strategy. While LLUB’s ARPU
300
250 has on average been higher than the industry, this gap has declined in recent
200
150 years. LLUB has also stated that its majority shareholder, Chevron, has no
100
50 immediate plans to divest its stake in LLUB.
0
2009 2010 2011 2012 2013 2014 2015 2016 2017
Industry (Ex. LLUB) ARPU (Rs.) LLUB ARPU (Rs.)
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.
Source: PUCSL, Taprobane Research
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, specifically at the outer port limit (OPL). Nevertheless, this
requires specialized barges 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
LKR70/share (Ke -17%, g - 0%). We recommend SELL.
Coverage Initiation TAPROBANE | RESEARCH

Income statement summary (LKR m)

Y/e 31 Dec CY15 CY16 CY17 CY18e CY19e CY20e CY21e
Revenue 11,564 12,089 11,052 10,823 11,593 11,826 12,183
Gross Profit 5,196 5,671 4,741 4,410 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 3,406 3,060 3,125 3,188 3,170
Interest (expense)/ income 175 187 90 16 33 30 39
Profit before tax 4,319 4,703 3,496 3,076 3,158 3,218 3,208
Taxes (1,231) (1,221) (931) (861) (884) (901) (898)
NPAT 3,088 3,481 2,565 2,215 2,274 2,317 2,310

Cashflow summary (LKR m)

Y/e 31 Dec CY15 CY16 CY17 CY18e CY19e CY20e CY21e
Profit Before Tax 4,319 4,703 3,496 3,076 3,158 3,218 3,208
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) (108) (116) (118) (122)
Cash from Financing Activities (2,040) (4,200) (3,240) (1,993) (2,046) (2,085) (2,079)
Net Changes in Cash 1,049 (429) (1,886) 597 72 144 124
Free Cash Flow 3,089 3,771 1,354 2,590 2,118 2,229 2,203
Free Cash Flow per Basic Share 13 16 6 11 9 9 9
Operating Cashflow per Share 13 16 6 11 9 10 10

Balance sheet summary (LKR m)

Y/e 31 Dec CY15 CY16 CY17 CY18e CY19e CY20e CY21e
Property, Plant & Equipment 2,196 2,133 2,067 2,023 1,989 1,960 1,936
Total Current Assets 4,759 4,839 3,452 4,133 4,428 4,707 4,992
Total Assets 7,045 7,047 5,596 6,232 6,494 6,744 7,005
Total Current Liabilities 2,059 2,820 1,181 1,711 1,745 1,764 1,793
Total Long-Term Liabilities 303 366 408 408 408 408 408
Shares Outstanding * 240 240 240 240 240 240 240
Book Value per Share 20 16 17 18 19 20 20
Total Liabilities & Equities 7,045 7,047 5,596 6,232 6,494 6,744 7,005
* adjusted for share split

Ratio analysis
Y/e 31 Dec CY15 CY16 CY17 CY18e CY19e CY20e CY21e
Revenue growth (%) 0.4 4.5 (8.6) (2.1) 7.1 2.0 3.0
EBITDA growth (%) 18.5 8.9 (23.6) (9.9) 1.9 1.9 (0.6)
Gross margin (%) 44.9 46.9 42.9 40.7 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 20.5 19.6 19.6 19.0
Return on equity (%) 62.5 81.5 65.2 53.8 53.7 50.7 48.1

Source: Company Data, Taprobane Research

Coverage Initiation TAPROBANE | RESEARCH
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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.