)
The Titan scrip made a new one-year low of Rs 201.20 intra-day today before closing 13.3 per cent lower at Rs 204.90 versus a 0.53 per cent fall in the Sensex. This takes the stock's fall to 27 per cent since June 4, when the Reserve Bank of India (RBI) came out with new restrictions on gold imports.
While the market had a sense of the implications, today's fall follows the Titan management's profit warning issued in an analyst conference call on Tuesday evening. According to the management, RBI's increasingly stringent norms on gold imports will hit its earnings per share (EPS) and return ratios in the medium term. The company, however, has so far not witnessed any impact on consumer demand for gold jewellery. Most brokerages have downgraded the stock post the call, trimming their EPS estimates (by 13-15 per cent) and target prices.
"We downgrade Titan to 'hold' from 'buy' as we see its return ratios declining due to higher working capital as it likely funds its gold requirements through direct imports. While we don't see a risk to Titan's business model, and remain positive on the growth of branded jewellery, we expect its FY14 and FY15 earnings to be 15 per cent lower (versus earlier estimates) due to higher interest costs on a leveraged balance sheet. We cut our target price to Rs 225 from Rs 290," says Gaurang Kakkad, an analyst at Religare Capital Markets.
Higher working capital is also estimated to pull down Titan's return on equity (RoE) from 42 per cent in FY13 to 35 per cent in FY14, say analysts. The key to prospects, consumer demand, remains unperturbed, but stringent measures could weigh on demand.
Though Titan is looking to increase the proportion of studded jewellery and other businesses (watches, eye care) to reduce risks further, these will fructify over a longer term.
Regulatory changes to hurt
The government and RBI have taken a slew of measures to curb gold imports. The government, for instance, has raised import duty on gold from two per cent in January 2012 to about eight per cent now; the last hike of two percentage points was in early this month. Last week, the central bank also prohibited credit for import of gold for domestic use from suppliers or bullion banks. This means companies such as Titan will have to import gold at prevailing spot market prices and by paying 100 per cent cash. Earlier, the company used the gold-on-lease route to source the yellow metal at about 3.5 per cent interest from banks, MMTC, etc. This shift will impact Titan in two ways.
First, Titan will need additional working capital to buy gold. Analysts estimate the requirement at Rs 2,500 crore in FY14. Religare analysts estimate the funds will stretch Titan's balance sheet, resulting in a net debt of Rs 1,450 crore in FY14 from a net cash position of Rs 1,140 crore. Hence, while net debt/equity will rise 0.6 times in FY14, the company will also start incurring interest costs.
Second, the company will incur additional costs to hedge risks arising from adverse gold price movements. However, lower letter of credit charges and one per cent value-added tax savings (on utilisation of gold import licence) will offset hedging costs to some extent, believe analysts. Titan is permitted to directly import 10 tonnes of gold under the current licence against its annual requirement of 20-22 tonnes.
Opportunity in adversity?
There could be a potential silver linings for Titan. First, falling gold prices could lead to higher demand for gold jewellery given Indian customers' fondness for the yellow metal. Second, while higher interest costs can be better-managed by large organised players such as Titan, unorganised players may find it difficult to absorb them. Thus, the latter may resort to price hikes, which could increase preference for jewellery from organised companies.
"The most important driver for Titan is the shift to organised retail / market share gains. A falling gold price environment places Titan in a competitively favourable position, since most unorganised players are likely to face severe balance sheet constraints on account of unhedged gold positions. However, growth during such phases is likely to come predominantly from store expansion rather than same-store-sales, which could constrain margins," says Rajasa Kakulavarapu, equity analyst at Jefferies. While the company has put its expansion plans under review, analysts await clarity on this front.
Though Titan, too, has the option of passing on the higher costs to its customers, the company is watching the competitive situation closely. Analysts estimate Titan can wipe out the earnings hit by raising making charges. "Just to illustrate, an additional Rs 600 per 10g (or 2-2.5 per cent) of higher gold charges to customers can mitigate the entire EPS impact for Titan. The ability to pass on such a quantum of price increase is indeed there as long as competitive forces allow the same," says Rohit Chordia, consumer products analyst at Kotak Institutional Equities.
