Missing bustle

According to one interpretation, Tanishq derives its name from tan (body) and ishq (love). It’s slightly ironical then that the love affair of Titan Industries’ flagship business with the Indian consumer seems to have soured recently. How else would one explain the performance of its stock price, which was up 60% last year, and has corrected more than 20% since its recent high in November 2012? 

Titan has been a darling of the stock markets, admired both for its governance and performance track record. Over the past five years, as its overall revenues and profits grew 31% and 41% respectively, its market-cap multiplied eight-fold. But that glitter seems to be wearing off now. Ironically, the same factors that contributed to its growth so far are posing a challenge now. 

The undisputed star in Titan’s portfolio, Tanishq brings in more than 80% of overall revenues through 176 stores that sell gold and diamond studded jewellery. It’s a bet that clearly paid off for Titan when it entered this space. Launched against wide scepticism in 1994, the jewellery business gradually made its mark, growing by 36% in the past five years alone. 

In 2012, though, some of the sheen had begun to wear off. Same store sales (sales from stores that have been in operation for at least one year; also called ‘like-to-like (LTL) sales’) rose by a modest 8-10% over the past three quarters of FY13, compared to 25% in the preceding three quarters. This was the lowest growth rate among all of Titan’s product lines. But it had little to do with the company’s operating philosophy or even its strategy, which has served it well for nearly two decades. All-time high prices of gold were in fact to blame, and these deterred buyers from flocking to jewellery stores. That was a hard blow in an economy singed by inflation and mired in uncertainty. 

Party Spoiler

It is no secret that Indians love their gold. Festive splurges, wedding season sales and the security of gold as an investment asset make it the country’s second-largest imported item, after crude oil. In FY12, India imported $56.5 billion worth of the precious metal, up 50% from the previous year. As gold imports increased further this fiscal, making up nearly half of the current account deficit, the government decided to curb gold imports by hiking the customs duty from 4% to 6% in January this year to control the deficit. 

While that did set in fresh concerns over waning demand for jewellery, there are greater worries related to two key proposals by the RBI. If implemented, these will not only increase financing costs for the company but also impact its working capital. The first recommendation to link gold leasing rate to the base rate would push gold leasing rates up from the present 3.5% to 8-10%. Under a lease arrangement, the buyer — in this case, Titan — pays rent on gold till it is consumed. The gold contracts are closed at the time of product sale and not at the time of purchase. This way, no inventory is carried, avoiding any mark-to-market loss or gains. 

Titan, which is the only company allowed to import gold directly — apart from banks and state-owned firms — shifted most of its procurements to local banks after RBI cut the lease period from 180 days to 90 days for gold procured through state-owned firms such as Minerals and Metals Trading Corporation (MMTC) and State Trading Corporation (STC). But now, RBI has proposed to cut the leasing period for banks too. Titan has been in talks with the authorities to maintain status-quo, but it is unclear whether the central bank will oblige. 

Analysts say that a longer lease period is vital for Titan as it takes around 120 days to sell the leased gold and pay back the banks or state-owned firms. At 90 days, it would have to pay for unsold gold as well, which could impact not just its working capital and cash flows but expose it further to volatility in gold prices. Global investment bank Jefferies estimates that the impact of an increase in gold lease rates and decrease in lease period on Titan’s earnings could be as much as 11%. In such a case, the company’s management has indicated that it would go for direct imports where it can at least improve on margins.

Silver lining

All this won’t amount to much till consumers start buying again. “Unless there is an improvement in overall sentiment, gold demand is unlikely to recover sharply,” says Gautam Duggad, vice-president, Motilal Oswal. An uptick just might be around the corner and the upcoming wedding season should bring in some cheer for Titan and others in the business. 

Unless, of course, the proposed amendment to the Prevention of Money Laundering Act kicks in sooner. The amendment, which extends know your customer (KYC) details to a larger universe of gold buyers, will require retailers to furnish PAN for purchases above ₹50,000. Presently, KYC details are mandatory only for customers who buy gold worth over ₹5 lakh. It’s unlikely though, as a recent Morgan Stanley report indicates, that this amendment will apply only to bullion and precious gems and may not include jewellery retail. 

Then again, given its market leader position in the organised jewellery retail space (5% share), investors could do well to cut it some slack. It has taken quite a while for the watchmaker to build a respected brand in the jewellery market, estimated at ₹135,000 crore. In a business where unorganised and family-owned jewellers dominate with nearly 90% share, Titan’s competitive strengths and consumer focus earns praise from brand consultant Harish Bijoor. “Titan does not give customers what they want today. They are always one step ahead and offer customers what they will need tomorrow,” he says. He points to the company’s latest brand, Mia, aimed at the working woman, where it’s addressing what promises to be a big market in the coming years. The fact that consumers have been shifting from local jewellers to national chains as they become more discerning about quality and design, augurs well for Titan too.

It fits in with the strategic shift that Titan has been grappling with for some time now. The watch business defined brand Titan until some time ago. Today, watches contribute less than one-fifth to total revenues, and price hikes to pass on increased input costs have reduced volume growth. So, even as revenues grew by 13% in the first nine months of FY13, volume growth for the watch business has been rather modest at 2%. “Watches are becoming more a part of consumers’ discretionary spend rather than a necessity,” says Abneesh Roy, associate director, Edelweiss Securities. “Most people have mobile phones, which now double up as their watch.” No wonder, Titan is looking to expand the sales network of its high-end brand Helios. There are currently 41 stores and the company is looking to add another 100 in two-three years. The Helios stores also house 25 international brands. 

Titan’s other businesses — engineering and eyewear — bring in about 4% revenues. Titan Eye+ has emerged as the largest retail eyewear chain in India with 215 stores, and revenues from eyewear have grown by 10% in the first nine months of FY13. Analysts are more excited about the Fastrack brand where the company retails fashion accessories like bags, belts and wallets. Titan plans to include more categories like helmets in the near term and target the kids market through the Zoop brand.

Standing tall

For now, jewellery is the star to watch out for. While a 10-year bull run since 2002 saw a CAGR of nearly 20% in gold prices, Titan’s jewellery business model has never been tested in a situation like now. Its management track record, so far, offers some comfort. While the new store expansion that the company undertook in FY13 will lead to higher operating costs, analysts concede that in a full year of operation these showrooms will augment the company’s revenue growth. The company is expected to post revenue growth of 21-22%, earnings growth of 23-24% and an operating margin of 9.5% in FY14. Analysts also expect the company and its peers to pass any increase in costs to consumers. 

Store expansion has been measured, though. During the first nine months of FY13, of the targeted space addition of 200,000 sq ft in its jewellery business, Titan added 110,000 sq ft, and is looking to close the year with 150,000 sq ft added. According to analysts, the company has indicated that the balance will be added in the June 2013 quarter. “Retail store expansion is a very critical part of strategy because same store growth has been a challenge,” says Edelweiss’ Roy. “The only way to prop up growth has been through new store expansion as it helps in gaining market share from unorganised players.” 

Titan isn’t the only one. All leading jewellers including Tribhovandas Bhimji Zaveri and PC Jeweller are looking to add new stores to grow sales. Kerala-based Kalyan Jewellers has opened three showrooms of 15,000 sq ft each, in Mumbai recently. “Cannibalisation and competition are issues we shouldn’t ignore,” caution Citigroup analysts Aditya Mathur and Jamshed Dadabhoy in their report on Indian retail jewellery. They say that increased competition is the reason Titan’s revenue growth, despite a 25% retail space addition, was only 14% on a y-o-y basis, during the first nine months of FY13. 

If the new regulations on gold imports come through, Morgan Stanley estimates that Titan’s return on capital employed, which stood at 63% at the end of FY12, could be hit by 15%. What’s encouraging is that Titan is expected to generate free cash flow of more than ₹875 crore in FY13, which should help fund its increased working capital needs. 

Ace investor Rakesh Jhunjhunwala must be seeking comfort in the cash being generated, for he recently added 71,000 shares, increasing his stake to 10.31%. At its current price of ₹245, the stock trades at 24.5 times its estimated FY14 earnings. That’s lower than its 10-year forward average multiple of 26 times. But remember that the high forward multiple was a function of high expected growth, which is in question now. So, what should you do? The stock has support around the ₹ 220 level. Therefore, one needs to  watch out for this level. If it holds in the days to come, go ahead rekindle the romance. If not, then wait it out.