Goenka Diamond and Jewels IPO Analysis

Investors can refrain from subscribing to the Initial Public offer of Goenka Diamond and Jewels (Goenka), which processes diamonds and manufactures diamond jewellery.

In its price band of Rs 135-145, the offer values the company at 10.7-11.5 times the annualised per share earnings on a post-issue capital. While not very expensive in absolute terms, this is at a premium to listed players such as Gitanjali Gems.

The company has clocked healthy growth rates, caters to a wider customer base, and has margins superior to most listed peers.

However, we believe its new retailing business poses significant execution risks, going forward.

The time likely to be taken in building a robust brand suggests that it may be better to take a wait-and-watch approach to this offer.

The company's brands are still in infancy, and address the mid-to-high-end range. Current and projected retail reach is minimal, and most issue proceeds are earmarked for the retail foray.

The company's primary business involves cutting and polishing rough diamonds, and manufacturing and retailing jewellery.

At the upper end of the price band, the company will raise Rs 145 crore, to be deployed towards expanding its retail chain, increasing manufacturing capacities and investment in an overseas subsidiary.

Diamond exports

Exports form about 70 per cent of sales in both 2008-09 and the nine months ending December 09, down from the 81 per cent in 2007-08. Domestic sales account for the rest.

Goenka also brought down exposure of its diamond business to the riskier US market to 13 per cent of exports for the nine months ending December 09, from the 66 per cent in 2007. Besides the US, the company exports to Hong Kong (which forms a re-export hub) and South-East Asia. About Rs 7 crore of the issue proceeds will fund expansion in manufacturing capacity through the setting up of a jewellery manufacturing plant and a diamond processing plant in Mumbai.

Subsidiary investment

Goenka has a subsidiary, M.B. Diamonds, in Russia, one of the largest diamond producers. This allows the company to source rough diamonds, its primary raw material, directly through diamond auctions held there, which would reduce raw material costs. The subsidiary also has a unit to polish diamonds. The entire output of the subsidiary — both processed and rough diamond — is sold to the company. Of the issue proceeds, the company will invest Rs 25 crore in the subsidiary to fund working capital and other expenses.

Goenka's sales recorded a three-year compounded growth rate of 127 per cent, while net profits grew at 290 per cent, largely on account of drop in raw material costs.

Gross margins, therefore, improved significantly from 4.4 per cent in FY-06 to 7.4 per cent in FY-09, further moving up to 9.8 per cent in the nine months ended December 09. Net margins similarly improved from 1.2 per cent in FY-06 to 6.1 per cent in FY-09.

Retail network

Strong sales and profit margins aside, the key risk to this offer, stems from its concentration on its retail business.

About 75 per cent of the issue proceeds will be deployed towards increasing store count for its two brands G Wild and Ceres.

Both launched in 2008, G Wild is a mid-to-high end designer diamond jewellery brand while Ceres is wholly high-end.

Plans are to build on the reach of these brands. 17 stores of G Wild and two of Ceres will be opened by end-FY-12. This retail foray holds execution risks on multiple counts.

One, the branded jewellery market may be nascent, but Goenka already faces stiff competition from the diamond offerings of Gitanjali Gems in the mid-priced segment and international brands as well at the high end. Breaking into the market may well take time.

Two, given the size and the spread of the jewellery market, the store network will require much more scaling up to truly exploit opportunities of an expanding market. Margins may also come under pressure on the back of high rentals on stores and increased brand promotion exercises.

Three, working-capital requirement for these stores appear rather high, given the small size of the store network.

The company has, in its prospectus, estimated working capital cycle at 232 days for Ceres and 184 days for G Wild.

Compare this to the 310 days for Gitanjali Gems which has a larger store network numbering hundreds including shop-in-shops and distributors.

Therefore, the company's potential may be judged post-listing, and after it showcases its ability to scale up store presence and firm up brand recall.

Offer details

The issue is open from March 23 to 26. On offer are one crore shares.

SBI Capital Markets is the lead manager to the issue.