Titan Industries: Buy :: Business Line

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The company’s strong position in the jewellery business should help it cope with the change in the business model.

The recent sharp fall in the stock of jewellery and watch maker Titan Industries provides a good buying opportunity for investors with a long-term perspective.

The company’s leadership position in the organised jewellery business and its robust finances should help it weather the impending changes in its business model. At its current price of Rs 224, the Titan stock discounts its trailing 12-month earnings by around 27 times, lower than what it has traded at in the past (32 to 40 times).

Despite near-term challenges, earnings growth should pick up in the medium-to-long term, offering return potential.

Business model change

Over the last fortnight, the Titan stock has slipped significantly following an intensified push by the Government and the Reserve Bank of India (RBI) to curb gold imports.

On June 4, the RBI imposed restrictions on import of gold by nominated agencies. Then, the government increased Customs duty on gold imports from 6 per cent to 8 per cent. The central bank clarified to Titan that all imports of gold for domestic consumption can now be made only with 100 per cent cash margin, and that credit of any kind for import of gold for domestic use is prohibited. This means an end to the gold-on-lease model being used by jewellers such as Titan. This saw the stock crash 23 per cent before recovering some lost ground. The new rules will result in changes in Titan’s business model, and an increase in interest expenses and hedging costs. The jewellery business segment is Titan’s largest accounting for around 80 per cent of its sales and profits.

Under the gold-on-lease model, Titan enjoyed a credit period of up to 180 days within which it could settle payments for the gold it purchased based on the rate at which it sells to end-users. This helped it hold low gold inventory and save on interest cost.

The lease rate in the range of 4-5 per cent annually was lower than what the company would have to pay on borrowings (around 10 to 11 per cent annually) to fund gold purchases in cash. Besides, the gold-on lease-model provided Titan a hedge against gold prices declining.

Now, with gold purchases to be paid for upfront in cash, Titan will have to resort to more short-term borrowings for working capital and incur interest expenses.

This could also mean a decline in ‘other income’, which accounted for around 10 per cent of profit before tax in FY-13.

These will mean lower net margins for the company and a fall in its return ratios. Also, the company’s margins in the jewellery business may be subject to swings in gold prices. The company has indicated that it will review its store expansion plans in the light of the new developments.

Positioned to adapt

That said, Titan should be able to manage the transition reasonably well and could, in fact, gain an edge over competition in the jewellery business.

The company is the largest jewellery retailer in the country and has a direct import licence.

Direct gold imports (instead of sourcing it from banks and other agencies) will help Titan avoid value-added tax of 1 per cent.

The direct import route can take care of around half the company’s annual gold requirement. Its strong balance-sheet should also help Titan easily tap loans on favourable terms to meet funding needs. Also, the company has indicated its plans to hedge its gold imports through other means. This could possibly be through commodity exchanges.

The impact of the business model change may cause deterioration in Titan’s financial metrics initially but this may not have a lasting impact on growth. The company should also be able to pass on costs to customers.

In addition, a dip in gold prices should translate into strong volume growth for Titan. In the March quarter, despite high prices, demand for jewellery in the country rose 15 per cent.

A decrease in gold price, as seen in recent times, translated into higher volumes for Titan with the management indicating very strong growth in April.

After its scorching run over the last few years and the subsequent correction, gold price is expected to remain benign and grow at a moderate rate.

This should help keep demand for gold jewellery robust and help Titan’s prospects.

Healthy financials

Aided by a strong performance in its jewellery segment, Titan’s FY-13 revenues grew 15 per cent to Rs 10,009 crore and its net profit rose 21 per cent to Rs 725 crore. Return on equity was a robust 42.5 per cent.

The jewellery business has been doing well. In FY-13, despite low single digit growth in volumes, the segment’s revenues grew 15 per cent and operating profit rose 28 per cent.

The share of the higher margin studded jewellery was at 32 per cent of jewellery revenue in the March quarter compared to 27 per cent for FY-13.

In the March quarter, volume growth was 9 per cent. While the company may tread cautiously on its store expansion plans in the current fiscal, the pace should pick up once the dust settles.

The watch segment, Titan’s second largest, enjoys 65 per cent share in the organized watch market in India. But higher cost of imported components, and curbs on discretionary spending in difficult economic times have taken a toll on its performance.

In FY-13, volumes fell around 1 per cent and operating profit declined 7 per cent. Titan’s ‘others’ segment which includes the eyewear business picked up steam. Revenues grew 26 per cent in FY-13, albeit on a low base. Importantly, the segment posted operating profit in the second half of FY-13.

Low debt and cash balance of around Rs 1,140 crore as on March 2013 gives Titan room to tap into debt at reasonable rates.