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All that glitters is gold

N Mahalakshmi & Sunil Nayanar | April 11, 2005

As long as your women are fascinated with gold, goldsmiths will make money. The only difference being that some will make more money than others. The jewellery industry is going through a period of transition with more players scaling up operations, increasing their global footprint through outsourcing and/or venturing into the most touted growth area -- the domestic retail business. Listed companies, which have been focusing on exports till now, are now joining the domestic growth story.

Supported by a systematic flow of good news, stocks of certain jewellery makers have been surging at the bourses. Since January 2005, the share price of Rajesh Exports, the country's largest gold jewellery exporter, has increased by 129 per cent. The share price of Titan Industries, which derives about half of its revenues from its jewellery division Tanishq, has also gained 23 per cent.

However, Su-Raj Diamonds, which has been in the business of cutting and polishing diamonds traditionally and is upping its stakes in the gold jewellery business, has been muted. Can these jewellery makers hold on to their sheen?

More gold at home...

The demand for gold was never in doubt. India is the world's largest importer and consumer of gold, with annual consumption of around 800 tonnes. In value terms, the Indian gold market is estimated around Rs 45,000 crore (Rs 450 billion). Even as gold becomes more attractive as an investment option, women's fascination for gold jewellery coupled with rising disposable income would mean more jewellery sales.

...and beyond

The export business has been shining. The Indian gems and jewellery industry is growing fast. Exports of gems and jewellery touched $14 billion during 2004 -- a 38 per cent growth over last year's $10.39 billion. There has been growth in the jewellery sector, too, with exports growing 78 per cent growth y-o-y in 2004.

Indian-made jewellery gained momentum in the US markets in the recent past and industry experts believe that several global retail giants like Wal-Mart and JC Penney are likely to source jewellery from India. Besides, players are now turning out to newer markets like EU countries and South East Asian markets where Indian jewellery is more lucrative than those from other countries.

India also has the cost advantage apart from skilled and cheaper labour force, which makes it an attractive outsourcing option for global players. India's market share in the jewellery sector was $2.5 billion, which is just 4 per cent of the world market. So there is significant scope to increase jewellery exports. However, the sustained rise in the rupee is likely to eat into profit margins of exporters.

The golden landscape is changing

For ages, Indian women have been used to getting their most exquisite jewellery made by their trusted family jewellers. Of late, however, educated urban women are asking: how pure is your gold? Since family jewellers fail to impress customers in terms of purity of gold, women are looking elsewhere -- that is, to branded jewellery stores like Tanishq and Oyzterbay.

Apart from pure gold they also get modern designs. During calendar 2004, the demand for branded jewellery in the country grew around 30 per cent and accounted for about 20 per cent of total sales. As against this, regular gold jewellery sales grew in single digits. The big challenge for branded jewellery makers is penetrating the country's interiors where the country's biggest gold buyers reside.

According to a study by consulting firm McKinsey, the branded jewellery market in India would grow by 40 per cent per annum to Rs 10,000 crore (Rs 100 billion) by 2010. Domestic jewellery players are reinventing themselves to get a share in this growing business. Each of the listed players has a different business model. Here are three companies to watch out for.

Titan: The country's largest watch maker, Titan's jewellery division Tanishq is focused on the retail side with about 70 retail outlets across the country. It outsources manufacturing. Tanishq has gained acceptance from elite customers, thanks to its adherence to quality standards and modern designs. Tanishq has been able to grow its sales by around 20-25 per cent over the past few years.

Titan is expected to close the year with total sales of Rs 1,107 crore (Rs 11.07 billion) of which nearly a half comes from Tanishq. In terms of profits, however, Tanishq contributes just about a quarter, essentially because the profitability of the jewellery business is significantly lower than its other business at this point.

Analysts expect Tanishq to post a growth of 25 per cent in sales and 28 per cent in EBITDA over the next couple of years. Impressed by its growing watch business and restructuring efforts, analysts have a buy on Titan. In FY 05, Titan's earnings per share should be Rs 8.1. Currently, the stock trades at Rs 241 indicating a price-earnings ratio of 29. But analysts estimate FY07 EPS at Rs 20 implying a forward P/E of 12x.

Rajesh Exports: India's largest exporter of gold jewellery is planning a major retail thrust to create the country's most integrated gold jewellery player. It has capacity to process about 250 tonnes of gold into jewellery, which in value terms would mean about Rs 13,000-14,000 crore (Rs 130-140 billion).

Over the next year or so the company has plans to increase its retail presence by acquiring traditional jewellers in south India. The company has earmarked Rs 450 crore (Rs 4.5 billion) for its retail initiative, of which, about Rs 370 crore (Rs 3.7 billion) will go towards acquiring 100 retail outlets and Rs 80 crore (Rs 800 million) will go towards ad spends and other brand building efforts.

The strategy of acquiring existing jewellers instead of setting up new outlets in an already overcrowded marketplace appears to be a good strategy.

The acquisition price for retail outlets seems way off the Rs 100 crore (Rs 1 billion) capital employed by Tanishq for setting up 70 outlets across major metros. Spending Rs 3.5 crore (Rs 35 million) per outlet seems to be on the higher side especially in the southern states. While the southern markets are very lucrative, it is difficult to take a call on how soon these investments will pay off.

It expects three-fourth of its total turnover to come from retail sales in four years. During this period, the company expects to expand its net profits margins to 8-10 per cent. In FY05, the company is expecting to close with sales of Rs 3,500 crore (Rs 35 billion) and a net profit of Rs 50 crore (Rs 500 million).

In the first three quarters, the company has recorded net profit of less than 50 per cent of that figure. If this happens, FY05 EPS would stand at Rs 70 implying a P/E of 9.77 at the current price of Rs 684.

Further, if one assumes that the company is able to achieve a net margin of 4 per cent over the next two years, the stock will have an EPS of Rs 195 meaning a FY07 P/E of 3.48, still cheap. However, the sharp run up in the stock combined with low floating stock makes the stock vulnerable to manipulation.

Su-Raj Diamonds: Engaged in the diamond business for many years, Su-Raj is now changing focus to the jewellery business. But the retail bug hasn't quite bitten the company. It plans to retain its focus on the B2B segment and is increasing its manufacturing capacities in Goa and Manikanchan.

Though the company has picked up a 49 per cent stake in Ahmedabad-based Forever to cater to domestic customers, the company will remain focused on exports. It is not hopeful of increasing its margins but will make up for it growing its sales.

It expects sales growth of 35 per cent per annum over the next three years. The 9-month annualised earnings per share for FY05 stands at Rs 7.46. At current price of Rs Rs 38, the stock trades at a P/E of 5.08. If the company achieves its targeted growth, FY 07 EPS will amount to Rs 13.60, indicating a P/E of 2.7.

We aim for bottomline margins of 8-10 per cent: Rajesh Mehta

Do you think your retail foray will improve your margins?

Yes. Once our retailing operations are in place, we will be the only fully integrated jewellery player in the world. We will be doing refining, bullion trading, manufacturing, wholesaling, exporting and retailing. Thanks to this cycle, margins will be higher. We are eliminating wholesalers and retailers in the middle, which will give a boost to margins.

Can you explain the economics?

The elimination of wholesalers will result in cost savings of 16-18 pert cent. Of this, we will pass on about 3-4 per cent to customers. The rest will trickle down to our bottomline. Our manufacturing costs are only 1 per cent while jewellery is sold in retail shops at a premium of 20 per cent to gold prices. So there is a gap for us to play.

Why do you think your retail strategy will succeed?

We are going to offer customers the best purity in gold, the largest range of designs, international finish, best services and value for money. We are confident of offering jewellery at prices comparable to family jewellers. We will also offer attractive jewellery purchase schemes.

Why did you decide to acquire traditional jewellers rather than setting up your own shops?

Jewellery buyers go by trust. By acquiring traditional jewellers and offering them a vast design range, advertising support and competitive prices, we will be able to attract customers.

What kind of topline growth are you looking at?

We expect to keep the topline constant for the next four years and focus on the bottomline. In the next 18 months, we want 25 per cent of our topline to come from retailing. And in the next four years, we want 75 per cent of our topline to come from retailing. We aim to achieve bottomline margins of 8-10 per cent over four years. In FY05 we plan to achieve a topline of Rs 3,500 crore (Rs 35 billion) and a bottomline of Rs 50 crore (Rs 500 million).

What stops other players from duplicating your model?

We have lots of proprietary procedures and technology, which no other company has. We use a special kind of alloy, which nobody else is using. We have a large R&D division. Nobody can copy our design range. If anyone attempts to copy, costs will be much higher than our selling costs.

We expect topline growth of 35 per cent: Jatin Mehta

How does the recent acquisition of Forever help you?

We have picked up a 49 per cent stake in Forever for Rs 3.5 crore (Rs 35 million). Forever has a nationwide network, targeting the domestic B2B jewellery market. Through the acquisition, we aim to tap the high growth domestic gold and diamonds jewellery segment. Forever's business profile is complementary to Su-Raj Diamonds -- while jewellery from Su-Raj will cater to international B2B clients, Forever will tap the domestic B2B market.

Forever's merchandise offerings include jewellery and accessories in diamond and gold. They are currently selling to all major domestic retailers like Tanishq and Chintamani. We sell all kinds of jewellery, including corporate gifts.

Do you expect your margins to improve?

Margins in this business are not high because we are catering to informed customers. It is an open-book operation and customers know the break-up of our costs. So there is little scope for margin expansion. However, we will make up for it through volume growth.

Why have you chosen to stay away from retail?

Retail foray requires a lot of investments in brand building. We are not sure if we are ready for that. Our key strength lies in our standards and production capacities, which fit well in a B2B framework.

Where will growth come from over the next three years?

We are expecting a topline growth of 35-40 per cent per annum over the next three-four years. Sales will be led by the jewellery business. In the diamond business we have already reached a plateau; so we may not grow there.

How will the rupee appreciation affect you?

Rupee appreciation is a concern. Since we import nearly 80 per cent of inputs, the currency appreciation will affect us only to the extent of our value addition. How we will be affected depends on how our currency moves compared to key competitors like China. We will have to cut costs.

What about gold prices?

We do not speculate on gold price. We enter into fixed-price contracts depending on our requirement. The demand tends to be weak when gold prices are unsteady. However, even when prices have risen substantially over the last couple of years, demand has been robust. People like to buy jewellery at whatever price. We do not expect demand to slacken due to rising prices.

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