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JB Securities (Pvt) Ltd
Current Price : Rs. 111
Target Price : Rs. 116
Target (12 m) : Rs. 122
Dividend (12m) : Rs. 33
Recommendation : Buy/Hold
Chevron Lubricants Lanka Limited
Valuation Update - 2008
Company Ticker: LLUB.N0000
Industry : Manufacturing
Heading into Rough Seas!
Increased competition and escalating production cost will apply downward
pressure on volumes and margins, slowing down the growth in profits.
However the company will continue to retain its dominance in the lubricant
market and generate strong cash flows. Hence we believe the counter to
have potential to offer an attractive total return to investors.
Higher ROIC, despite intensifying competition: Intensifying competition will reduce
the pricing power of all industry incumbents, including Chevron. However we believe
that the company is in a position to maintain margins and achieve bottom line growth
albeit at a slow rate. However the company will continue to post high returns on invested
capital (ROIC) due to the low asset base required for operations.
Higher FCFE & dividends: Effective working capital management and declining capex
requirements contribute to higher FCFE and sustenance of higher dividends. We expect
the company to make a substantial dividend payment in the financial year 2008 & 2009
primarily from the cash generated in the 2007 financial year. The company will continue
to retain its capacity to maintain a high dividend payout in the future.
Financial Indicators
10th September 2006
Why read this report?
We value Chevron using
scenario based FCFE
valuation model.
We disclose our valuation
methodology in detail so
that an astute investor can
tailor the valuation in the
way he wants.
We highlight the possible
risks to Chevron.
Address:
JB Securities (Pvt) Limited
No:150, St Joseph’s Street,
Colombo 14
Sri Lanka
General: +94112490900
Web : www.jbs.lk
JBS Research
September 2008
JB Securities (Pvt) Ltd does and seeks to do business with companies covered in its research reports.
Investors should be aware that the firm may have a conflict of interest that could affect the objective of this
report. Investors should consider this report as only a single aid in making their investment decision.
0%
25%
50%
75%
100%
125%
150%
175%
200%
225%
Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08
ASPI
Chevron
Share performance relative to ASPI
Capitalisation as at 4th September 2008
52 w eek range, Rs.Market cap, Rs.Net debt, RsFree floatShares outstanding
Forecast/ValuationCurrent 2008F 2009F 2010F
EPS, Rs 17.97 19.87 22.10 21.36 DPS Rs. 13.00 16.00 33.00* 17.00 Price, Rs 111.25 - - - P/E 6.2 5.6 5.0 5.2 NAV, Rs 30.56 28.49 35.57 40.27 P/BV 3.6 3.9 3.1 2.8 GP Margins 26.4% 26.6% 26.6% 24.2%ROIC 50.9% 58.3% 58.2% 50.8%
Price & ASPI Performance1M 3M 12M
Chevron 9.4% 5.0% 34.1%
ASPI 1.7% -6.3% -2.7%
* Special dividend- From excess cash
81.75-113.256,780,000,000 (571,061,722)
49%60,000,000
Content
1. Why Read This Report 1
2. Industry Update 2
3. Key Factors to Consider for 2008 and beyond 3
4. Investment Thesis 10
5. Valuation Summary 12
6. Valuation Methodology in Detail 13
7. Scenario Analysis 14
7. Appendix – 1, Shareholder List 17
8. Glossary and Abbreviations 18
Why read this report
The effect of the following has been newly factored in to the Chevron Valuation Report
2008.
Macroeconomic Factors
Rising inflation caused by the higher commodity prices, expansionary budget of
GOSL, and its impact on the cost of capital and exchange rates
Industry Specific Factors
Commencement of operations by the following new entrants
1. Motul SA France – France
2. Bharat Petroleum Co. – India
3. Sinopec Co. – China
4. Gulf Oil Int. – UAE
5. Laugfs Holdings Ltd – Sri Lanka
Lanka IOC commencement of blending operations during the year
Reduction in price increases effected due to increase in competition
Valuation Assumptions
All scenarios have been modified to incorporate change in the competitive
intensity
1. Scenario 1: Base case - Sacrificing market share over the years with
reasonable negative pressure on margins
2. Scenario 2 : Base case with further market liberalization
3. Scenario 3 : Scenario 2 with increased capex and further competition
Cost of capital is adjusted to reflect the rising inflation
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 1
Industry Update
Demand for lubricant slowed in 2009
The Sri Lankan lubricant market consumed approximately 55-56 million litres in
2007 in volume terms. Relative to 2006 volumes declined marginally by 1-2%.
Decrease in the use of automobiles, lengthening service intervals and the slowdown
in the growth of the vehicle stock resulted in a reduction in demand coming from
the automobile segment. Increase in thermal power generation and increased
demand from the defence forces helped to cushion the drag on total volumes.
The lubricant market is yet highly concentrated with Chevron dominating with a
market share of 84-86% followed by LIOC with 7-8%, Mobil, Shell, BP/Castrol,
and Valvoline account for the balance.
Laugfs Lubricants, Sinopec, Mac Lubricants, Gulf Oil and Motul commenced
operations during the year. We believe Laugfs to be an aggressive competitor than
the incumbent players. Laugfs will import its lubricants in bulk form and pack it
locally whilst the other players will import their volumes in packed form.
The Ceylon Petroleum Corporation (CPC) has also expressed its interest in re-
entering the lubricant market. We believe that CPC would have access to 9-10% of
the total industry volume via its network of fuel stations and preferential access to
key state sector accounts such as the Ceylon Transport Board.
LIOC commenced operation in its blending plant in November 2007. Players
blending lubricants locally still enjoy a tariff advantage of 8.7% albeit lower than
the previous 16.6%. LIOC is also in the process of intensifying its distribution
channels.
Given the expected slow growth in overall industry volumes, entry of new
competitors and existing players intensifying their operations will threaten the
market share of Chevron. Given that most of the new entrants will be pricing their
products very close to those charged by Chevron we believe that there is a strong
possibility of Chevron experiencing erosion in market share. The degree of erosion
will depend on how Chevron will react to competitors’ moves.
Market Size and
growth
Market Shares
New entrants
commenced operations
during the year
CPC has expressed its
interest in re-entering
the lubricant market
LIOC commenced
blending lubricants,
intensifies operations.
We expect Chevrons
market share to
reduce over time.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 2
Key factors to consider for 2008 and beyond
Sustaining high margins key to maximising value to shareholders
Chevrons ability to maintain strong margins which drives the value of the company
will depend on whether the management will emphasis margin maintenance as
opposed to market share. Based on discussions we have had with the
management we strongly believe that the company will focus on the former
whilst modestly sacrificing volume and market share.
Chevron will be challenged on both the revenue and cost fronts in the coming years.
Increase in base oil prices and macro economic instability will drive costs up whilst
the entry of new players and the existing players such as Servo intensifying its
operations will hinder Chevrons ability to pass on these cost increases to the full
extent. Hence we expect current margins to be maintained in the short term whilst
experiencing marginal decreases in the medium to long term. However modest
declines in the gross margins will not hinder the company’s ability to generate
strong cash flows and maintain a strong return on invested capital given the
very limited needs for investments and low overhead costs.
Increase in overall cost of production driven by increase in base oil
prices
We expect cost of production to increase by 10-11% for the year 2008 recording an
increase of 20-21% over the second half as opposed to a decrease of 8% in the 1st
half, relative to 2007. This is due to base oil prices increasing by 45-50% in June,
relative to prices in December 2007. Chevron made a price revision effective from
June 2008 of 20%. This will enable Chevron to maintain its margins during the
current financial year.
Beyond 2008 we have factored in an increase of 20-27% in cost of production per
litre again mainly driven by base oil price increases. We expect base oil prices to
increase between 25-30% in rupee terms, with prices increasing by 20-25% in dollar
terms and a rupee depreciation of 5%.
Base oil prices settle after a series of price hikes
Base oil prices increased during the 1st half of 2008 in response to the rapid rise in
crude oil prices. Relative to prices recorded in December 2007 base oil prices are
now up by 45-50%.
We expect cost of
production to increase
by 20-21% in the
second half of 2008.
Increase in competition
will apply negative
pressure on both
margins as well as
volumes.
We believe Chevron’s
management to trade off
market share and volume
for margins, which
underpins its value.
Base oil prices
increased sharply with
rise in crude oil prices.
The recent declines in
Beyond 2008 we are
factoring in production
cost per litre to
increase by 20-27%.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 3
The decline in crude oil prices over the past 4-5 weeks has helped to calm the base
oil markets, but these declines will not pass on to base oil since, despite the series of
price hikes made, many refiners are still faced with low margins. As reflected in the
following exhibit crude oil prices rose above the price of base oil during the first
quarter of 2008.
Exhibit 1- Movement of base and crude oil prices
0.2
0.25
0.3
0.35
0.4
0.45
0.5
0.55
0.6
0.65
0.7
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul
US$/LitreUS$/Litre
Base oil
Crude oil
2006 2007 2008
Source: www.lubereport.com and JBS Research
The jury is still out on where crude oil prices could go but given the fundamental
problems of lack of growth in supply and the geo political risks surrounding many of
the oil producing nations, observers are of the view that the decrease recorded in the
recent past is only temporary and that crude oil could increase past the record high of
147.27$ per barrel posted in July. We have factored in a continuous increase in base
oil prices taking into consideration the uncertainty surrounding the direction of future
price changes.
Improvement in gross margins in 2007 and the 1st & 2nd quarter of 2008 was due to
Chevron acquiring base oil at lower price towards the end of the 3rd and 4th quarters
of 2007 as well as in January 2008. We estimate the average cost of a litre imported
during these periods to be approximately 2-3% lower relative to stocks purchased in
2006 and early 2007.
Exchange Rate Depreciation
Given that approximately 90% of the cost of production consists of imported
components the depreciation in the rupee will apply upward pressure on costs. We
have incorporated a 3% depreciation in the currency for the financial year 2008 and
expect it to increase to 5% in 2009 and beyond. Inflation levels, success on the battle
front and the emphasis on maintaining the competitiveness of exports will be key
factors driving the movement of the exchange rate.
We expect the rupee to
depreciate by 3% in
2008 and to depreciate
further by 5% in 2009
Given that the decline
in crude oil prices is
considered temporary
we could expect base
oil prices to increase
further in the future.
The recent declines in
crude oil prices
however, will not trickle
down to base oil.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 4
Exhibit 2 – Exchange Rates and Forward Premiums
Forward Premium
Current 1 Month 2 Month 3 Month 6 Month
US$ 107.55 0.70 1.35 2.35 5.30
As at 08/08/2008
Source – JBS Research
As at May 2008 the rupee was overvalued by approximately 14-15%. Given the
current political scenario and the pressure to reduce inflation we believe that the
government will continue to intervene in the markets to ensure a certain degree of
stability in the rupee, at least for the next 3-6 months. However this would have to be
balanced out with the objective of maintaining the competitiveness of the country’s
exports as well. Hence we expect the government and the central bank to allow the
rupee to depreciate between by 2-3% during the year.
Exhibit 3 – Exchange Rates and Forward Premiums
Year Month REER Over/Under Valuation
2008
January 108.83 8.83%
February 111.69 11.69%
March 111.65 11.65%
April 112.49 12.49%
May 114.42 14.42%
Source – Central Bank of Sri Lanka
High inflation rates to continue
The rate of inflation has been rising since the later half of 2006, which is currently in
the range of 26-28%. Considering the expansionary budget of GOSL, the effect of
double digit inflation is expected to remain over the short to medium term.
Chevron will retain ability to pass on cost increases albiet at a slower
rate and maintain margins
The lubricant market is still highly concentrated with Chevron. We estimate their
market share to be between 82-86% at present. Strong market penetration and a well
oiled distribution channel enabled Chevron to pass on cost increases freely and
maintain strong gross margins historically. However the increasing competitive
intensity will limit Chevrons ability to pass on cost increases freely in the future.
Rupee overvalued by
14.4%, high inflation
and government
spending expected to
drive exchange rate
down
Increase in the
competitive intensity
will limit Chevron’s
ability to pass on cost
increase freely.
Inflation is rising due
to the expansionary
budget
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 5
Exhibit 4 – Increase in prices vs costs
2006 2007 To date
Price revisions made
Lanka Super DS 40 32.4% 10.4% 20.0%
Lanka Super Plus SAE 40 33.4% 10.1% 20.0%
Delo SAE 40 32.4% 6.0% 20.0%
Havoline SAE 40 32.4% 10.2% 20.0%
Increae in costs
Base oil prices 52.2% -1.4% 12.0%*
Overall cost of production 24.0% 9.6% -8.0%
* Change in average purchase price relative to December 2007
Source – JBS Research
The entry of several new players and Servo increasing its distribution and marketing
activities coupled with slow industry growth could result in an erosion of market
share and also hinder Chevrons ability to completely pass on cost increases in the
future. However since we expect Chevron to continue to hold a large share in the
market, and given the effectiveness of its distribution channel, we strongly believe
that Chevron would be able to pass on cost increases to the extent needed to maintain
a high GP margin without an adverse impact on volumes. However modest decreases
in margins should be expected over the medium to long term as the competitive
intensity in the industry increases.
New players enter the market
Mac Lubricants, Gulf Oil, Sinopec, Total and Laughs received their licenses to
commence distribution and marketing of Lubricants in Sri Lanka in 2007 and all
players commenced operations during the first half of 2008.We believe Laughs to be
an aggressive player and would pose a greater threat to Chevron relative to the
incumbent players. The Ceylon Petroleum Corporation has also expressed its interest
in re-entering the lubricant market; their entry could pose a significant challenge to
Chevron (Refer ‘Understanding the Lubricant Industry’ report).
Servo commenced blending, Increased its Intensity in Operations
Servo commenced blending lubricants at its plant in Trincomalee in November 2007.
Further it has intensified its operations in the market by setting up 9 distributors
which currently account for approximately 1/3 of the volume sold whilst the balance
flows through LIOC sheds. Servo currently enjoys a market share between 7-8%.
The company has experienced a volume growth of approximately 20% relative to
last year.
Given that Chevron is
strongly entrenched in
the local market we
believe that the
company could pass
on a significant portion
of their cost increase
albeit at lower rate.
5 new players
commenced operations
in the first half or 2008.
We believe Laugfs to
be an aggressive
player. CPC also has
expressed its interest
in re-entering the
market.
LIOC has commenced
blending lubricant
locally and has also
take action to
strengthen its
distribution channel
and marketing efforts.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 6
No change in the game plan of other players has been witnessed
We expect the other players such as Mobil and Shell to grow at a rate marginally
lower than the historical growth rates. We have not seen a major shift in their
strategy. Further given that their products target a cliental that is less sensitive to
increase in prices and inflation we do not believe that they will experience a larger
drop in volumes as well. Standing of each players in-terms of volumes and market
have been set out below.
Exhibit 5 – Market share and volumes of other players
2007 2003-2007
Player Volume Market share Growth
BP/Castrol 903,296 1.7% 17.7%
Shell 1,179,730 2.3% 18.6%
Mobil 1,031,039 2.0% 28.1%
Valvoline 515,789 1.0% 61.6%
Total 3,629,853 7.0% 24.2%
Source – JBS Research and Sri Lanka Customs
Shift in product mix towards high value and high margin products will
help to reduce pressure on margins
Chevron has taken action to shift customers away from low value products such as
Lanka Super Plus and Lanka Super DS towards high value items such as Delo and
Havoline. These products yield a higher value per litre, enabling Chevron to earn a
higher margin.
Further the company is also aggressively promoting speciality products such as
coolants to both the automotive segments and the industrial segment. Discussions
with management revealed that the thes products yeild a 4% higher margin than
conventional products. At present speciality products account for 10% of revenues
and the company hopes to increase this to 30% over the next 5 years.
Exhibit 6 – Shift to high value products
Diesel engine oils Petrol engine oils
Rs. per litre
328
445
Lanka Super DS SAE 40
Delo SAE 40
381
551
Lanka Super
Plus SAE 40
Havoline SAE 40
Source – JBS Research
We have not witnessed
a significant change in
the game plan of the
incumbent players.
Change in sales mix
towards high value
products and speciality
products which
command high margins
would also facilitate
maintaining high
margins.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 7
Industry growth will be low mainly driven by the slow growth in the
vehicle population
We expect industry volume growth to average between 1-2%, down from the
historical average of 5-6%. The key factor driving our lower expectation is the
slowdown in the expected demand from the autmobile segment of the market, whislt
we do not see a surge in demand coming from the industrial segment of the market
sufficient to offset this slowdown.
Demand for automobile lubricants will slowdown
The automobile segment of the market accounts for approximately 84-86% of the
total demand for lubricants. We believe the the following factors will negatively
impact the demand coming from the segment.
- Reduction in the number of services being performed
Rapid increase in fuel prices, increase in vehicle service costs, and general
inflation have driven up the costs of running a vehicle resulting in delaying of
the service intervals as well as reduced mileage.
- Slowdown in the growth in the vehicle population with current growth mainly
being driven by small engine vehicles
High tariffs and high interest rates prevailing in the country has resulted in
reduced demand for vehicles such as cars, motor lorries and buses. At present
the growth in the vehicle stock is primarily driven by motor cycles and three
wheelers.
- Ban on 2 stroke three wheeler imports
The Sri Lankan government imposed a ban on the importation of 2 stroke three
wheelers, effective from January 2008. Whilst the existing 2 stroke three
wheeler stock will be allowed to operate the government will also ban the
importation of spare parts from 2011 onwards. These actions collectively will
result in a decrease in the 2 stroke three wheeler population and the gradual
increase in 4 stroke three wheelers. Given that 4 stroke three wheelers consume
39% less lubricants relative to a 2 stroke engined three wheelers, we expect the
growth coming from this segment to slow down, and the abosolute consumption
levels to come down as well, in the long run. At present consumption from three
wheelers account for 7.4% of demand from the automobile segment.
We expect industry
growth to be in the
range of 1-2%.
Demand from the
automobile segment
will slowdown.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 8
Industrial demand is assumed to be flat
We expect industrial demand which accounts for approximately 15-20% of the local
volume to also post marginal growth. Underlying this belief is the expected slow
growth/decline in thermal power generation which accounts for 35% of the lubricant
consumption in the industrial segment, whilst no major growth is expected from
other major industrial users. Although consumption from the forces increased by 13-
15% in 2007, a further increase in lubricant consumption from the defense forces
cannot be expected.
Heavy rain fall experienced during the 1st half of the year and the expected
commissioning of mini hydro power plants will reduce the growth in demand for
thermal power in 2008 and also 2009 provided that the current rainfall patterns
continue. We have factored in a growth rate of zero for thermal power generation for
2008 and 2009 and a marginal growth rate in the years beyond assuming that the
CEB would be able to commission new plants as planned. Delays in implementation
of many projects such as the Kerawalpitiya Combined Cycle Plant puts into question
the ability of the CEB to increase supply of electricity over the next 2-3 years.
However due to the prohibitive cost of operating diesel powered thermal power
plants, we cannot expect CEB to further increase the dependence on such plants.
Industrial demand will
also remain flat.
We do not expect the
installed base of diesel
based thermal power
generation to increase
given the sharp
increase in the cost of
diesel.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 9
Investment Thesis
Business
Chevron will continue to generate strong returns on its capital and cash flows
Decrease in market share and decline in margins over the medium to long term will
not a have significant negative impact, and Chevron will continue to generate strong
returns on its capital. Our base case scenario indicates that the company could
generate a 49.5% return on invested capital (ROIC) on average for the next 5 years,
even in the face of declining margins and market share. This is higher than the
historical 5 year average RIOC of 46.3% due to the minimal need of capital to
support bottom line growth. Given the relatively low need for capital expenditure the
company will continue to generate strong cash flows to equity holders.
Chevron continues to retain its dominance
The key factors that differentiate Chevron in the industry, strong brand and
established distribution channel enable the company to maintain a strong presence in
the market. However we expect the company to lose market share albeit at a slower
pace.
Dominant position of Chevron will enable passing on cost increases
As explained before we expect cost of production to increase in the future driven by
increases in base oil prices. However given the strong market dominance of Chevron
and the nature of the product, we believe that the company will be able to pass on a
significant portion of the cost increases to the end consumer.
Our forecasted average gross margin (GP) and net margin (NP) for the next 5 years is
23.8% and 10.4%, which is lower than the historical 5 year average GP and NP
margins of 38.4% and 13.9% respectively in the base case scenario.
Valuation
Chevron’s fair value is Rs. 116 per share, target 12 month price is 122
Chevron is currently trading at PER of 6.1, whilst our fair value estimate points to a
justified PER of 6.4. Whilst a relatively slower growth profits could limit the
potential for large capital gains in the future, the high dividend payout rate
maintained by the company will enable investors to earn a relatively attractive total
return.
At the current price our fair value estimate offers a margin of safety of 1-2%. We
believe that estimates used by us to be fairly conservative and hence coupled with the
above margin of safety offers sufficient protection against deviations from the actual.
Chevron will continue
to generate strong
cash flow and high
returns on capital
despite the increase in
competition and rise in
costs.
Chevron will continue to
dominate the market, but
would lose market share
to a certain extent.
Chevron’s dominance
will enable the
company to pass on
bulk of the increases in
costs to the end
consumers.
Chevron has a fair
value of Rs. 116 per
share.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 10
Risks
The major risks that should be considered are,
- The increase in the competitive intensity and changes in strategies adopted by
the exiting competition
- Possibility of further players entering the lubricant market
- Possibility of CPC not extending the lease on the land at Kolonnawa
Chevrons lubricant blending plant is located on a land belonging to the
Ceylon Petroleum Corporation(CPC). The lease agreement is expected to
end in July 2009. However it is not certain whether CPC would consider
extending the agreement since they are also considering entering the
lubricant market. It is too early to pass judgment on the issue. However in
the event an extension is not made Chevron’s management has stated that
they would be considering the following options
1. Blend their total demand abroad and import. If this option is pursued
the company would lose the tariff advantage it currently enjoys.
2. Relocation of the plant. The plant is fully owned by Chevron. Hence the
company could dismantle the plant, and move it to an alternate location.
However given that the plant has been up and running for more than 10
years, they will only move components that were recently installed
whilst purchasing components that have a limited future life.
There is a possibility of
Chevron loosing the
land on which the
blending plant is
located, which is under
lease from CPC.
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 11
Valuation Summary
Methodology
We use scenario based Free Cash Flow to Equity (FCFE) valuation model.
Dynamics of the lubricant industry necessitate a combination of multiple scenarios.
We have developed three scenarios.
Scenario 1; Base Case – Management focus on maintaining margins
whilst sacrificing market share
Scenario 2 – Base case with further players entering the market
Scenario 3 – Scenario 2 with additional players entering and increase in
capex
We have assigned probabilities to these scenarios depending on the likelihood of
their outcome.
Exhibit 7 – Summary performance
2005 2006 2007 F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
EPS* 11.67 13.45 17.97 19.81 22.10 21.36 20.43 20.45 21.43 23.34 26.74 31.95 33.63
DPS* 9.75 9.50 12.50 16.00 33.00+ 17.00 15.00 14.00 15.00 17.00 20.00 22.00 22.00
NAV* 21.14 25.09 30.56 28.49 35.57 40.27 46.10 52.18 58.17 64.13 70.18 79.50 90.79
Current share price 111.25
P/E** 6.19 5.62 5.03 5.21 5.44 5.44 5.19 4.77 4.16 3.48 3.31
Dividend yield** 11.2% 14.4% 29.7% 15.3% 13.5% 12.6% 13.5% 15.3% 18.0% 19.8% 19.8%
P/B** 3.64 3.90 3.13 2.76 2.41 2.13 1.91 1.73 1.59 1.40 1.23
* Expected figure, weighted by probability of the realization of each scenario
** Based on closing price as at 4th September 2008
+ Special dividend from excess cash as at 30th June 2008 of Rs. 1,094,085,303
Source – JBS Research
Exhibit 8 – Valuation of Chevron
Source – JBS Research
Scenario 1 Scenario 2 Scenario 3
Value of equity during the explicit period 4,894,340,978 4,665,439,008 4,052,905,979
Value of equity during the continuing period 2,639,750,887 2,505,431,191 1,893,995,852
Value of equity 7,534,091,865 7,170,870,199 5,946,901,831
Number of shares outstanding 60,000,000 60,000,000 60,000,000
Per share 126 120 99
Probability 50% 20% 30%
Weighted price of Chevron 62.78 23.90 29.73
Weighted average price of Chevron 116
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 12
1st 5 years 2nd 5 years
Base oil cost 65.9% 26.8% 18.0%
Other direct material and overheads 34.1% 18.2% 12.8%
AverageComponent
Share of
production cost
Valuation Methodology in Detail
Principle Assumptions
The following basic assumptions will be kept unchanged in all three alternative
scenarios.
We have assumed total induatry demand to grow at an average rate of 1% and
3.4% for the 1st and 2nd 5 years respectively. This is lower than the historcial
CAGR of 5.7%, due to our expectation of slower industry growth.
A blending plant may operate at an optimal utilisation of 95% of its total capacity.
The volume produced in excess of the optimal utilisation will be produced in
extended work shifts.
We have incorporated the following increases in costs when forecasting cash
flows.
Exhibit 9 – Assumed increase in cost of production
Source – JBS Research
Historical trend will continue.
Existing working capital policies will continue.
Deferred tax liability balance is assumed to remain constant.
Conforming to its past practice Chevron will continue to pay a dividend equal to it
FCFE.
Probabilities
Scenario 1: 50%
Scenario 2: 20%
Scenario 3: 30%
Industry growth is expected
to be slower than the
historical rate.
The optimal utilisation of a
blending plant is 95%
A future CAGR of 26.8% in
base oil prices have been
factored in.
Probabilities
Capital Structure
Working Capital
Deferred Tax
Dividend
JB Securities (Pvt) Ltd Valuation Update 2008
JBS Research 13
Scenario Analysis
Scenario 01; Base Case – Management focus on maintaining margins
whilst sacrificing market share
This scenario is based on the assumption that the management will focus on
maintaining a sufficiently high margin and the resulting increase in prices will drive
their market share down. Based on the discussion we had with the management we
strongly believe that the company will pursue this objective.
The key assumptions underlying this scenario have been set out below.
Exhibit 10 – Key assumptions
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Growth in prices 20.0% 19.5% 19.5% 19.5% 19.5% 19.0% 18.0% 17.0% 15.0% 13.0%
Growth in volumes -8.2% -3.4% -3.6% -4.9% -5.7% -6.6% -6.7% -6.3% -1.0% -0.2%
Gross margin 26.6% 26.6% 24.2% 21.6% 20.1% 19.4% 19.2% 19.7% 20.1% 19.2%
Net profit margin 12.4% 12.0% 10.4% 8.8% 7.7% 7.3% 7.1% 7.4% 7.7% 7.2%
ROIC 58.3% 58.2% 50.6% 41.6% 36.2% 33.5% 32.7% 33.8% 36.0% 33.7%
Market share 80.9% 77.4% 73.5% 68.8% 63.6% 58.3% 53.1% 48.3% 45.7% 43.5%
Source – JBS Research
As set out above under this scenario we expect Chevron to maintain an average GP
margin of 23.8% in the first five years and 19.1% in the second 5 years. This is lower
than the historical GP margin of 28.1% .The reduction is mainly due to the rapid
increase in cost of production and the limited ability to pass on the cost increases as
competitors strengthen their position in the market. Maintaining the margins at above
levels would enable the company to maintain a high return on capital and strong cash
flows as well.
The key financial line items have been set out in the following table.
We strongly believe that
the management would
focus on maintaining a
higher margin whilst
sacrificing market share.
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JBS Research 14
Exhibit 11 – Key financial line items
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Income statement
Revenue 9,583 11,109 12,858 14,703 16,713 18,789 20,976 23,389 26,996 30,925
Gross profit 2,552 2,953 3,107 3,174 3,353 3,638 4,032 4,602 5,427 5,924
Operating profit 1,775 2,030 2,045 1,961 1,973 2,081 2,286 2,647 3,190 3,396
Net profit 1,188 1,330 1,341 1,287 1,295 1,366 1,499 1,734 2,087 2,221
Balance Sheet
Fixed assets 508 536 587 656 731 819 927 1,073 1,198 1,218
Working capital 1,641 1,923 2,299 2,718 3,152 3,576 4,001 4,438 5,093 5,898
Share holders equity 1,719 1,982 2,337 2,736 3,152 3,562 3,976 4,405 5,041 5,817
Liabilities 308 354 426 516 608 710 828 983 1,127 1,176
Cashflow statement
Gross CFO 1,261 1,428 1,440 1,388 1,401 1,477 1,617 1,861 2,224 2,360
Change in working cap 218 -250 -335 -374 -386 -377 -377 -388 -592 -727
Capex -75 -115 -138 -156 -163 -178 -201 -242 -225 -124
FCF from operations 1,404 1,062 967 859 852 922 1,040 1,231 1,407 1,509
Financing cash flow -28 5 19 29 27 33 45 74 43 -64
FCF to equity 1,377 1,067 986 888 879 955 1,085 1,305 1,450 1,445
Source – JBS Research
The realization of this scenario will put the fair value of Chevron at Rs. 126 and the
target value at Rs. 131.
Scenario 02; Base case scenario with further liberalization of the
market
This scenario asses the impact a further liberalization of the market would have on
the cash flows and the value of Chevron. Hence the key difference between the base
case and this scenario is a lower market share for Chevron over time.
The key assumptions underlying this scenario have been set out below.
Exhibit 12 – Key assumptions
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Growth in prices 20.0% 19.5% 19.5% 19.5% 19.5% 19.0% 18.0% 17.0% 15.0% 13.0%
Growth in volumes -7.7% -3.8% -3.3% -4.5% -5.2% -5.8% -5.7% -5.1% 0.0% 0.9%
Gross margin 31.4% 26.6% 24.1% 21.6% 20.0% 19.3% 19.2% 19.7% 20.1% 19.1%
Net profit margin 12.4% 11.9% 10.4% 8.7% 7.7% 7.2% 7.1% 7.4% 7.7% 7.1%
ROIC 58.3% 57.8% 50.4% 41.3% 35.9% 33.2% 32.4% 33.4% 35.6% 33.2%
Market share 80.9% 76.7% 72.8% 68.0% 62.6% 57.2% 51.8% 46.9% 44.2% 41.8%
Source – JBS Research
The average market share maintained by Chevron for the 10 years we have
considered decreased from 65.3% in the base case scenario to 60.1% in this scenario
due to our assumption of additional players entering the market. We have assumed
new entrants to commence operations in 2009, and despite the increase in
Scenario 2 assesses the
impact of a further
decrease in market
share, due to further
liberalization.
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competition for the management of Chevron to continue to focus on maintaining
margins at high levels.
The key financial line items have been set out in the following table.
Exhibit 13 – Key financial line items
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Income statement
Revenue 9,583 11,020 12,734 14,529 16,466 18,455 20,531 22,796 26,212 29,896
Gross profit 2,552 2,928 3,075 3,134 3,300 3,569 3,941 4,480 5,262 5,719
Operating profit 1,775 2,010 2,020 1,931 1,935 2,032 2,221 2,559 3,071 3,251
Net profit 1,188 1,317 1,325 1,267 1,270 1,333 1,457 1,676 2,009 2,126
Balance Sheet
Fixed assets 507 535 585 652 725 811 914 1,054 1,173 1,193
Working capital 1,641 1,908 2,277 2,687 3,107 3,514 3,918 4,328 4,949 5,706
Share holders equity 1,727 1,968 2,317 2,707 3,109 3,504 3,899 4,302 4,906 5,636
Liabilities 299 352 423 510 600 697 810 958 1,094 1,140
Cashflow statement
Gross CFO 1,260 1,415 1,423 1,368 1,376 1,445 1,574 1,803 2,145 2,265
Change in working cap 218 -236 -329 -365 -373 -361 -358 -363 -560 -683
Capex -74 -115 -137 -154 -161 -176 -196 -237 -219 -124
FCF from operations 1,404 1,064 958 849 841 908 1,020 1,203 1,366 1,457
Financing cash flow -36 12 19 28 26 31 42 70 39 -62
FCF to equity 1,369 1,075 976 877 867 938 1,062 1,273 1,405 1,395
Source – JBS Research
The realization of this scenario will put the fair value of Chevron at Rs. 119 and the
target value at Rs. 127.
Scenario 03 – Scenario 2 with increase in capital expenditure and the
entry CPC to the market
This scenario builds up on scenario 2 with the following additional assumptions,
1. The lease on the land on which the plant is located not being extended (See
‘Investment thesis, Risk’ above) and Chevron relocating its plant.
2. The entry of CPC
The key assumptions underlying this scenario have been set out below.
Exhibit 14 – Key assumptions
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Growth in prices 20.0% 19.5% 19.5% 19.5% 19.5% 19.0% 18.0% 17.0% 15.0% 13.0%
Growth in volumes -7.7% -2.9% -8.9% -5.7% -6.8% -7.6% -7.9% -7.7% -2.4% -1.8%
Gross margin 31.4% 26.6% 24.1% 21.5% 19.9% 19.2% 19.1% 19.5% 19.9% 18.9%
Net profit margin 12.4% 11.9% 9.5% 8.0% 7.1% 6.7% 6.6% 6.8% 7.1% 6.6%
ROIC 58.3% 51.7% 37.6% 33.2% 30.0% 28.5% 28.2% 29.4% 31.6% 29.4%
Market share 80.9% 77.5% 69.0% 63.5% 57.4% 51.3% 45.2% 39.6% 36.2% 33.0%
Source – JBS Research
Impact of increased capex
and further decrease in
market share has been
considered.
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We have assumed that CPC would enter the market in 2010, and as stated in the
lubricant industry report, would be able to capture a volume of 3-4 million litres
upon entry. We have further assumed that the plant relocation would cost between
Rs. 600-700 million, to be incurred in 2009.
The key financial line items have been set out in the following table.
Exhibit 15 – Key financial line items
F2008 F2009 F2010 F2011 F2012 F2013 F2014 F2015 F2016 F2017
Income statement
Revenue 9,583 11,123 12,111 13,642 15,194 16,715 18,170 19,619 22,011 24,436
Gross profit 2,552 2,957 2,914 2,929 3,028 3,212 3,462 3,823 4,380 4,630
Operating profit 1,775 2,023 1,757 1,669 1,651 1,708 1,826 2,046 2,402 2,456
Net profit 1,188 1,325 1,153 1,097 1,085 1,122 1,198 1,341 1,572 1,607
Balance Sheet
Fixed assets 508 1,085 1,002 962 949 960 996 1,071 1,131 1,131
Working capital 1,641 1,926 2,185 2,540 2,883 3,199 3,486 3,746 4,180 4,692
Share holders equity 1,727 2,543 2,660 2,900 3,155 3,405 3,644 3,871 4,272 4,752
Liabilities 301 345 404 480 555 632 715 824 917 948
Cashflow statement
Gross CFO 1,260 1,422 1,379 1,295 1,265 1,289 1,358 1,497 1,729 1,761
Change in working cap 218 -253 -226 -315 -303 -278 -249 -225 -388 -458
Capex -75 -664 -132 -146 -150 -160 -174 -206 -187 -124
FCF from operations 1,403 505 1,021 834 812 852 935 1,066 1,155 1,179
Financing cash flow -35 4 15 22 18 20 25 48 17 -51
FCF to equity 1,369 508 1,036 857 830 871 960 1,113 1,172 1,127
Source – JBS Research
The realization of this scenario will put the fair value of Chevron at Rs. 99 and the
target value at Rs. 102.
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Appendix - 01
Top 10 Shareholders 22nd August 2008 Number of
Shares %
1 Chevron Ceylon Limited 30,600,000 51.0%
2 HSBC International Nominees Ltd - BPSS - LUX - Aberdeen Global -
Asian Smaller Fund 3,559,600 5.9%
3 Sri Lanka Insurance Ltd - Life Fund 3,546,300 5.9%
4 Stone, R.A. 1,870,000 3.1%
5 HSBC International Nominees Ltd - Aberdeen Asia Smaller companies
investment Trust XCB9 1,790,400 3.0%
6 Cargo Boat Development Company Limited 1,020,000 1.7%
7 The Gilpin Fund Limited 800,000 1.3%
8 Kamon, K.R. 731,500 1.2%
9 Renuka Hotels Limited 714,700 1.2%
10 Employee Trust Fund Board 660,000 1.1%
Total 45,292,500 75.5%
Parent Company (Chevron Ceylon Limited) Holding 30,600,000 51.0%
Free Float 29,400,000 49.0%
Issued Share Capital at Rs. 10 60,000,000 100%
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Glossary & Abbreviations
1. Free Cash Flow to Equity (FCFE) - This is a measure of how much cash can be paid to the equity
shareholders of the company after all expenses, reinvestment and debt repayment.
Calculated as: FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New
Debt - Debt Repayment
2. Cost of Equity (Ke) - A firm's cost of equity represents the compensation that the market demands in
exchange for owning the asset and bearing the risk of ownership.
3. Net Operating Profit Less Adjusted Taxes (NOPLAT) - Total operating profits for a firm with
adjustments made for taxes.
4. Invested Capital – Capital/assets employed by a firm to run its operations
5. Return on Invested Capital (ROIC) - A calculation used to assess a company's potential to be a quality
investment by determining how well (i.e.. profitably) a company's management is able to allocate capital
into its operations. Comparing a company's ROIC with its cost of capital (WACC) reveals whether invested
capital was used effectively.
6. Earnings before Inters, Taxes, Depreciation & Amortisation (EBITDA) - EBITDA can be used to
analyze and compare profitability between companies and industries because it eliminates the effects of
financing and accounting decisions.
7. Maintenance CAPEX - Capital expenditure incurred to maintain the existing asset base.
8. Incremental CAPEX - Capital expenditure incurred in growth oriented activities.
9. CAPEX - Capital Expenditure
10. GP Margin - Gross Profit Margin
11. GOSL - Government of Sri Lanka
12. CEYPETCO- Ceylon Petroleum Corporation
13. Chevron - Chevron Lubricants Lanka Limited
14. Lanka IOC - Lanka IOC Limited
15. Mobil - Mc Larens Lubricant Limited
16. BP/Castrol - Associated Motorways Limited
17. Shell - N. M. Distributors (Pvt) Limited
18. Valvoline - United Motors Limited
19. H/ Avg - Historical Average
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20. F’cast - Forecast
21. ASPI - All Share Price Index
22. CODO - Company Owned Dealer Operated
23. DODO - Dealer Owned Deal Operated
24. Net Debt - Debt minus Cash
25. NAV - Net Asset Value ,i.e., Equity divided by number of shares outstanding
26. REER - Real Effective Exchange Rate
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