Some investors believe that the recent Central Board of Direct Taxes (CBDT) notification to quote PAN for the purchase of bullion or jewellery against a bill of R5 lakh or more will not impact Titan?s jewellery sales as only ~10% of sales are more than R5 lakh. We differ.

In our view, applying the rule to jewellery purchase could potentially act as a deterrent for jewellery sales, especially for organised players like Titan. Consumers may find ways to avoid compliance. However, the key point to note is that companies like Titan which will implement any regulation in letter and spirit could potentially be impacted disproportionately.

Industry sources indicate diamond prices are up ~40% in YTD CY11. While this could be positive for Titan?s June quarter, it could be significantly negative for H2 FY12E as the consumer uptrading benefit and resultant mix improvement seen in jewellery in the past may not continue. We note that inflation in gold over the past few years has made diamonds relatively cheap for the consumer. Titan?s studded jewellery sales rose to ~40% of total sales in FY11 from ~30% in FY07. Industry sources indicate that the margins of studded jewellery are ~2-3X higher than gold jewellery.

Q1 FY12E could be a good quarter; the rest of FY12E may not. Industry sources indicate jewellery demand during Akshaya Tritiya in May was very good in urban areas. Moreover, gold commodity has already appreciated ~8% year-on-year in April-June 2011. We note that inflation in gold is a tailwind for Titan as it improves absolute EPS and every 10% increase in gold price raises its jewellery margins by 50 basis points.

Lower GDP growth rate could hit watch sales growth in the near term. After more than 8% GDP growth rate in FY10 and FY11, the KIE economy team expects growth to dip to 7.7% in FY12E.

With the likely pressures in FY12E on demand conditions as well as margins, we see a low probability of earnings upgrades in FY12E. Our EPS estimates for FY12E and FY13E are R130.70 and R153.60, respectively, and we forecast EPS CAGR of 21% over FY11-14E. We retain earnings estimates and target price of R4,800 and reiterate our ?reduce? rating. Key upside risk is continuing inflation in gold commodity prices, which is a strong tailwind for earnings and jewellery margins.

Kotak Institutional Equities Research