Jewellery Retail - Gold curbs a short-term issue - Event Update - ANTIQUE

After a detailed discussion with RBI officials on the RBI notification dated 4th June 2013 Titan Industries management provided certain clarifications which is expected to impact earnings of jewelers by about 8-10% during FY14e and FY15e. On Titan Industries, we expect the impact on earnings to be to the tune of 8% per annum during FY14e and FY15e leading to an EPS of INR8.7 and INR11.1 respectively while in case of TBZ, we expect earnings to be impacted by 9% and 10% during FY14e and FY15e to INR18.1 and INR26.4. The difference in impact would be due to the benefit of VAT on direct imports available to Titan industries.

In our view, the Indian jewellery industry would witness a de-rating in the short term due to the government tightening on gold imports and the consequent impact on earnings. More importantly, the concern over the government's intent to restrict gold imports would have a bearing on the sector valuations in the short term as the probability of further such actions by the government cannot be ruled out. However we remain positive on the sector fundamentals over the medium to long term due to the low penetration of organised jewellery retail in the country. We recommend a HOLD on Titan Industries (PE- 20x FY15e) and TBZ (PE - 9x FY15e) in the current scenario with a target price of INR221 and INR237 respectively.

Titan's clarifications on the RBI notification

1) All imports of gold for domestic consumption, either through banks, nominated agencies or directly can be made only with 100% cash margin. 2) Credit of any kind from suppliers or bullion banks for import of gold for domestic use is prohibited. This also affects import of gold through all non consignment routes like gold on lease / loan. 3) RBI is firm that the implementation of the notification needs to be both in letter and spirit.

Titan Industries held a management conference call to provide further clarity on the press release by the company on RBI notification.

Following are the key highlights

- Gold sourcing effectively will be on spot basis as against the earlier practice of sourcing gold on lease.
- Titan will resort to direct imports of gold and will save thereby about 1% on VAT
- The company is looking at various options of financing the working capital for gold purchases.
- Titan expects to turn in to a net borrower in the next 3-4 months.
- Company will review its retail space expansion post the RBI notification
- The management is looking at various options for gold hedging. We understand that the company can hedge its complete gold inventory on exchanges.

Going by Titan's clarification, we expect the following impact on jewellery companies:

Interest cost would increase by about 550-750bps

Going ahead due to the higher cost of working capital as compared to the cost of gold on loan, interest outgo is expected to increase by about 550bps-750bps. Consequently the cost of working capital, we estimate would be at 10-10.5% as against the total cost of loan for gold at about 3.5-5%. This would lead to an impact of 8-10% at the PAT level. In Titan's case, the impact on earnings according to our detailed analysis (provided in the note) is estimated would be to the tune of 8% during FY14 and FY15 to INR8.7 and INR11.1 respectively, while in case of TBZ we estimate the impact on PAT to be about 9% and 10% during FY14 and FY15 respectively. The impact on Titan Industries would be lower due to the 1% VAT waiver on gold imports.

Titan's RoCEs to be impacted due to gold loan re-classification, more importantly RoEs will be intact

The reclassification of the debt for gold inventory, under the working capital debt as compared to the current practice of grouping it under the current liabilities would lead to an optical increase in capital employed (especially for Titan Industries as TBZ already classifies it under the working capital debt). RoCE of Titan Industries for FY14 and FY15 will drop to 27% from 48% in FY13. However Titan's RoEs will not witness any meaningful impact. The impact on RoEs will be limited to the impact on earnings.

No impact expected on jewellery sales

Despite the increase in cost of financing of jewellery companies post the RBI notification, we don't expect any change in consumption levels of jewellery. According to our channel checks, we understand that there has been a slowdown in the domestic jewellery consumption post a strong April and May 2013. We expect jewellery consumption would continue to be driven by the marriage season and consumer confidence. We continue to be positive on the sector from a medium to long term perspective.

Source : Equity Bulls

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