Titan management today provided clarification on recent RBI notification on
changes to the current terms governing import of gold. These new regulations will
have significant impact on Titan’s gold procurement model as current practice of
gold leasing will no longer be feasible and credit of any kind for import of gold
for domestic use is prohibited. These regulations would adversely impact Titan’s
interest costs and ROCE for the jewellery business. Mgmt noted that more clarity
on the new structure will be available over next few weeks as they are exploring
various options. This would imply uncertainty on this name for the short term and
adverse change in the business model may also lead to multiple de-rating. We
expect near term weakness in the stock to continue post sharp correction
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changes to the current terms governing import of gold. These new regulations will
have significant impact on Titan’s gold procurement model as current practice of
gold leasing will no longer be feasible and credit of any kind for import of gold
for domestic use is prohibited. These regulations would adversely impact Titan’s
interest costs and ROCE for the jewellery business. Mgmt noted that more clarity
on the new structure will be available over next few weeks as they are exploring
various options. This would imply uncertainty on this name for the short term and
adverse change in the business model may also lead to multiple de-rating. We
expect near term weakness in the stock to continue post sharp correction
Regulatory headwinds to adversely impact earnings/returns: RBI’s recent
notification implies that Titan would not be able to utilise the gold lease model
anymore and needs to fund gold purchases at spot price. Titan would hedge the
gold price. This would lead to Titan turning a net borrower (from current net
cash position) and would lead to substantial increase in interest charges. We
estimate ~10-12% adverse impact on FY14/15 EPS assuming Titan does not
pass the increased costs to consumers. Additionally increased capital
requirements to fund gold purchases would weigh on returns for jewellery
division which could likely come down from ~90% in FY13 to ~45% in FY14.
What could be the mitigating factors? Titan is looking to fully utilize its
licence for direct gold imports which would lead to ~1% VAT related savings.
Company is hopeful that they would be able to renew this license beyond the
current approved limit of ~10 tons (nearly half of its full year requirement). We
also believe the company may look to pass on some part of the additional cost
burden to consumers which would help mitigate earnings impact.
Would store expansion plans be impacted? Mgmt noted that FY14 expansion
plans are currently under review given incremental capital needs for gold
procurement. They had earlier stated their target to add ~100k sq ft of retail
space for their jewellery business. We have built in 80K sq ft of new space for
FY14. We think company may look to increase focus on franchisee model
where inventory is not on company's books.
Earnings/TP revision: We reduce FY14/15E EPS by 6-7% assuming Titan will
partly pass on the incremental costs. We also reduce our target P/E multiple to
23x (vs 25x earlier) on account of lower ROCE for jewellery division and near
term uncertainty related to the new gold procurement model. As a result our
Mar’14 TP is revised to Rs265.
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