Titan Industries reported strong Q1 resultsvolumes +67% in jewellery, partially benefited by the strong sales in April due to a correction in gold price. We agree that regulatory risks exist (similar to Pakistan recently banning gold imports for a month); however, we also draw comfort from Titans commentary that the organised jewellery industry is finding support from government institutions regarding business continuity.
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Our long-standing thesis of rationality in regulation holds well: We had always believed in the rationality of regulation (that the governments intention is to control the speculative demand in gold and not to hurt the organised jewellery industry). With the Reserve Banks recent clarifications about allowing gold on lease, it appears that indeed the intent is not to impact legitimate jewellery businesses.
Market conditions favour likely acceleration in market share: We continue to believe that organised players like Titan could get preference over unorganised players to get access to the imported gold for domestic sale due to their better relations with the nominated agencies. This is a favourable environment for Titan to gain market shares from the unorganised industry.
Strong expansion plans: Titan has a floor space addition plan of 100,000 sq. ft (+20% y-o-y) for FY14e, which, in our view is achievable (it has already added 37,000 sq ft in Q1FY14). Moreover, it could benefit from the ramp up in new stores opened in FY13 (it had added 145,000 sq. ft in FY13). We note that the typical ramp up of a new store is an index 30/60/100 over 12/24/36 months.
Resilient business model: Our confidence on Titans business model is reinforced after the Q1FY14e performance. It has successfully demonstrated the ability to keep the operating model insulated from an uncertain and complex regulatory environment (for example, utilising the domestic market for gold on leaseborrowing from the State Banks reserves of gold deposit scheme, from gold ETFs etc).
Valuation and risks: We have upgraded our FY14 and FY15 earnings estimates by 4-6% as we model higher volumes, faster space expansion and higher gold prices. We have increased our target price to Rs 295 driven by (i) earnings revision and (ii) ascribing a higher P/E of 30x one-year forward versus 26x previously. We believe a higher multiple is warranted as visibility has improved (operating model is intact despite regulatory challenges), strong earnings growth in FY13-15e (CAGR of 17% versus 13% forecast previously).
Key conference call takeaways
* The company has stopped coin sales from July 2013 to support the RBIs move of controlling speculative gold demand. During the current quarter, coins were 10% of the jewellery sales. The company is confident of making up for the lost gold coin volumes through other products .
* There are three reasons for the strong jewellery performance during the quarter: (i) a sharp correction in the gold price, (ii) more marriage days and (iii) the campaign on communicating the affordability of Tanishq.
* The gold deposit scheme has scaled up to Rs 4 bn out of the Rs 12 bn customer advances.
* An advertisement campaign to get new customers is being launched
* Volume of gold (grammage) per bill has increased for the first time in eight quarters. This supports the companys thesis that a falling gold price is compensated by a spike in volumes. There was a 40% increase in new customers during the quarter.
* Ironically, Akshaya Tritiya (festival) was not a big contributor to growth for Titan. The company maintains that the growth ex-festive sales have been higher.
* Regarding the regulation, the company said the obligation to export 20% is not on Titan but on the gold importer.
* The company enjoys a preferred customer status with banks and so the shortage of gold in the country due to the regulation would impact it the least.
* The price hike taken during the first week of April in watches negates the INR depreciation only until 53-54 USD/INR. There is a likelihood that the company could look at further price increases.
* The precision engineering business has sales of R2 bn. The company has nine months worth of orders.
* There was also Rs 340m MTM (mark-to-market) loss on gold held as customer advance. This is a non-cash loss.