Gitanjali Gems

The substantial price falls suffered by the stock of diamond jeweller, Gitanjali Gems, offers an entry for investors with a long investing horizon. At Rs 41, the stock has fallen 87 per cent from a high of Rs 315, in May 2008. The share trades at just 2.4 times its trailing standalone earnings versus closest competitor Titan’s price-multiple of 16 times.

The stock’s fall may have been precipitated by the floundering gems and jewellery industry — imports and exports deteriorated, both mining and production were put on hold —but appears to have discounted a fair bit of the negative news.

For Gitanjali, a rising proportion of domestic retail sales (as opposed to exports), a shift in product mix towards jewellery (from low-margin polished diamonds) and diversification moves suggest reasonable growth prospects over the long term.

The company’s presence across the value chain allows sourcing from both the Diamond Trading Corporation and other mines (helping better cost control), while forward integration in the jewellery business (from processing of rough diamonds into jewellery, branding and retail) lowers business risk and allows better margins than pure diamond exporters.
Key segments

Gitanjali operates in three main lines of business — diamonds and jewellery, the nascent lifestyle products and SEZs. Within the diamonds segment, the company processes (cutting and polishing) and exports diamonds; besides retailing diamond and gold jewellery in India and overseas. The jewellery segment did well in the past three years, clocking a CAGR of 63 per cent, with contribution to revenue going up from 22 per cent in 2006 to 42 per cent in the latest quarter.

The company expects to move to a 50:50 mix over the next year or so. This segment generates a better return on capital employed, 15 per cent versus the 1.5 per cent offered by diamonds (year-to-date figures).

Through the lifestyle business, the company retails watches, silver wear, cosmetics, perfumes, leather and accessories. Gitanjali’s SEZ initiative has not begun to contribute to revenues as yet.

Besides some in-principle approvals, it has one notified 80-hectare gems and jewellery SEZ at Hyderabad.In another initiative, Gitanjali recently entered into a joint venture agreement with the Kuwait-based Hassan’s Optician Company to secure a foothold in the eyewear segment.

Brand recall

Gitanjali is a top player in the branded jewellery market; the only other player with a significant national footprint being Titan Industries’, Tanishq. Gitanjali, however, leans towards the premium end, with an emphasis on diamond jewellery. Brands include the high-end Nakshatra and D’damas, daily wear Gili and Asmi, bridal collections Vivaha and Maya, pure-gold Collection G, and couples collection Sangini.

Most command good brand equity, and the infancy of India’s branded jewellery market will allow it to make the most of the opportunities thrown up as the market develops. Distribution is through ‘shop-in-shops’ housed in malls, independent jewellers, besides exclusive stores.

The domestic branded jewellery business appears very promising for the company at this juncture; a focus on premium jewellery leaves it less susceptible to cutbacks on spending by the mid-lower income groups.

The segment grew 20 per cent in the nine months ended December 2008. The problems related to global recessions and a cutback in US consumer spends may pose challenges for the diamond export segment.
On solid ground

Helped by its expanding retail footprint, Gitanjali’s sales have grown at a compounded annual rate of 25 per cent in the past three years, far surpassed by a 151 per cent growth in net profits in the same period.

A shift in product mix and cost-cutting measures pushed net profit margins from 1 per cent in FY 2005 to 5.2 per cent in the previous financial year. Gross margins improved from 2.5 per cent to 6.7 per cent in the same period.

Exports have always formed a bulk of revenues, though the share has come down to 52 per cent (December ’08 quarter) from the 71 per cent in 2005. Despite this, and significant imports, the company has not suffered any forex loss as yet.

Leverage is fairly low at 0.7 times (consolidated); coupled with a growing interest cover from 2.5 times in 2005 to its current 6.6 times, the company may not run into near-term funding roadblocks. Loans are primarily to fund working capital — the sector it operates in calls for high working capital. Its fund-raising spree through 1 per cent FCCBs and GDRs has left it with enough funds on hand to tide over for the next few quarters at least.
Challenges

Gitanjali’s SEZs concentrate primarily on gems and jewellery processing which is currently lacklustre. About $73.86 million of the FCCB, outstanding as of March ‘08, is due by 2011. Given the conversion price of Rs 220, the conversion option appears unlikely to be exercised, should the market price remain unattractive until 2011.

The bonds then may have to be redeemed, taking out more than Rs 250 crore of the company’s funds, assuming no conversion has taken place since March ‘08. Working capital forms about 40 per cent of sales; debtors make up almost half the assets with collection periods averaging five months. Hiccups in collection could restrict cash flows and revenues.