Renaissance Jewellery: Avoid

Investors can stay away from the initial public offer from Renaissance Jewellery. Though the offer is modestly priced and the company has a good financial record, the business carries a relatively high-risk profile at this juncture due to client concentration and US-centric operations.

The vulnerability of earnings to a US slowdown, dollar depreciation and the possibility of increase in gold or diamond prices peg up the uncertainties surrounding the earnings prospects.
Business

Renaissance Jewellery makes and sells studded precious jewellery to international retailers; it also has a small domestic presence through a retailing venture. Over 95 per cent of its revenues originate from the US.

The company operates three jewellery manufacturing units located in SEEPZ and Bhavnagar. Studded jewellery exports offer higher scope for value-addition and margins compared to the export of cut and polished diamonds, which is the predominant business for many of the Indian gem/jewellery exporters. A decade-long presence in this business and a good design pipeline have helped Renaissance establish strong relationship with key clients and steadily scale up its revenues and profits over the past few years.

While net sales (consolidated) have grown over two-fold to Rs 440 crore in the three years to FY-07, net profits have grown over three-fold from Rs 6 crore to Rs 25.4 crore over the same period. The planned expansion of capacities by 50 per cent, funded by this IPO, could aid the company in further scaling up revenues and profits should strong demand trends be sustained.
Uncertainties and risks

However, there appear to be a few uncertainties attached to the business prospects at this juncture. One, the company’s current sales are highly reliant on its top clients, with the biggest accounting for 42.3 per cent of revenues in FY-07 and the top five for nearly 95 per cent.

The company caters to large retail chains and wholesalers without any specific long-term sourcing contracts with the latter. This makes the business quite vulnerable to any churn in the client base.

Second, with over 95 per cent of the company’s revenues derived from the US, any slump in US retail sales could impact the company’s sales growth. Jewellery sales in the US markets are priced on a piece basis rather than on a cost-plus basis as is the practice in the Indian market. Therefore, the company’s ability to pass on any spike in raw material costs (on the prices of gold or diamonds) to customers may be limited, especially while competing with other suppliers.

Operating profit margins in this business are already thin, with the company managing a 6-7.5 per cent margin in recent years. With jewellery exports from India into the US ceasing to enjoy duty waivers under the generalised system of preferences with effect from July 2007, Indian exports have been exposed to higher competition than before.

Third, a higher tax incidence on account of the applicability of MAT to two of the company’s units from the coming fiscal may also potentially impact earnings.
New initiatives

The company however, has a few initiatives in place to address client and geographic concentration. For one, it plans to use the offer proceeds to fund a venture in the US which will target smaller and mid-rung retailers in addition to the large ones that are already being catered to. If successful, these efforts could help the company reduce its client concentration and gain better bargaining power as a supplier. Second, the company has forayed into markets such as West Asia to reduce its US dependence.

However, these initiatives are in a relatively nascent stage. Investors can closely watch progress on these fronts, post listing and consider exposures to the stock, at a later date.

Seen purely in terms of valuation, however, this offer is modestly priced in relation to listed players in the jewellery space.

The company’s net profits of Rs 25.4 crore for FY-07 translate into a per share earnings of about Rs 19.5 on the pre-offer equity base and to Rs 12 on the fully diluted equity base (factoring in warrant conversion). Based on the fully diluted equity for the sake of conservatism, this translates into the PE multiple of 10.5-12.5 times at the two ends of the price band.

Offer details: The company is offering equity shares in the price band of Rs 125-150, along with one detachable warrant, for every two shares. Each warrant is convertible into one equity share during the period from April 1 2009 and May 31 2009. The conversion will take place at a 25 per cent premium to the issue price for this IPO. IPO proceeds will be deployed towards investment in a foreign marketing subsidiary and substantial expansion of manufacturing capacities at Mumbai and Bhavnagar