Corporates. FY16 Outlook: Gems & Jewellery. Moderate Demand and Easing Regulatory Restrictions to Keep the Sector Afloat.

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1 Natural Resources Moderate Demand and Easing Regulatory Restrictions to Keep the Sector Afloat Outlook Report Sector Outlook STABLE Rating Outlook EXPORTERS STABLE (21: STABLE) RETAILERS STABLE (21: STABLE) Easing Regulatory Restrictions Economic recovery in Key Markets Shrinking credit availability Retailers to Outperform Exporters: India Ratings and Research (Ind-Ra) has maintained a Stable Outlook for gems and jewellery exporters as well as retailers for FY16. However, it expects retailers to outshine exporters. Exporters are subject to the vagaries of global demand, which is exhibiting mixed signals with the US and China showing improving and declining trends, respectively. Retailers are likely to fare better than exporters if domestic jewellery demand remains buoyant on moderation in gold prices. The agency expects exporters and retailers to report revenue growth between 3%-5% and 1%-12%, respectively, in FY16. Credit Profile of the Sector: Ind-Ra expects an improvement in average EBITDA margins for exporters in the range of 1-2bp and for retailers in the range of 1-3bp in FY16 on softening of rough diamond prices and easing of regulatory restrictions. Average interest coverage ratio is also expected to improve and stabilise at x in FY16. A lower interest cost due to the reinstatement of gold on lease scheme is likely to reduce both interest rate and average debt levels for industry players. In FY15, exporters faced the heat due to falling global demand and eroding margins. Revenue grew %-6% and EBITDA margins contracted around 5bp to 3%. In FY15, retailers showed resilience as consumption demand held its ground and consumers shifted preference towards organised jewellery players. Revenue grew %-1% and EBITDA margins remained stable between 7%-1%. Related Research Other Outlooks Special Commentary Outlook 21: Indian Gems & Jewellery Outlook FY16: Gold Price Go to appendix for list of rated entities Analysts Harsha Sodhani harsha.sodhani@indiaratings.co.in Mahaveer S Jain mahaveer.shankarlal@indiaratings.co.in Deep N Mukherjee deep.mukherjee@indiaratings.co.in Ratings Reflect Inherent Risk: Ind-Ra has already captured inherent risk in the sector in its outstanding ratings on gems and jewellery companies. The agency rates 17 issuers in the segment (nine exporters and eight retailers), of which only two companies have investment grade ratings, both being retailers. To the extent ratings reflect the risks, they are on a Stable Outlook. Shrinking Credit to the Sector: Indian banks have become cautious towards the gems and jewellery sector in the light of some big ticket defaults and restructuring recently. Such defaults to an extent may have been driven by idiosyncratic factors specific to the concerned corporates and may not be squarely attributed to specific sector issues. Closure of a major diamond trade financing bank based in Europe in October 21 has added to the financing pressure on diamond exporters. Credit availability remains a constraining factor and it could further hurt export volumes as this is a working capital intensive sector. Outlook Sensitivities Discretionary Spending: The key demand driver for the industry is the discretionary spending of end-consumers. Any deterioration in spending ability driven by decline of real wages in key overseas markets could affect the revenue of exporters. Volatility in Prices: Any supply disruptions leading to higher-than-expected rough diamond prices could affect the profitability of diamond exporters. Similarly, volatile gold prices will have a negative impact on the profitability of retailers to the extent their inventory is not tied up through gold on lease scheme. 1 June 215

2 Under the :2 rule, the Reserve Bank of India mandated banks and nominated agencies to ensure that at least 2% of every lot of gold import be exclusively made available for the export. This restricted gold imports for domestic consumption and increased local premium on gold procurement. Low base effect gave a fillip to the growth in gold exports in FY15. Gold exports fell about % in FY1 due to the restrictive policies imposed by the government in August 213. In value terms, gold exports are still 33% lower than FY13 values. Government Regulations: The government implemented several positive policy changes for the sector in FY15 such as the abolition of :2 scheme. Any further positive action by the government such as the reduction of custom duty on imports from present 1% will aid the sector. Uneven Global Recovery Weighs on Exporters Overall exports of the sector improved by 1.7% in the US dollar (USD) terms in FY15 (FY1: negative 15.1%). This was despite a 3.2% yoy decline in the exports of cut and polished diamonds, supported by a 12.5% rise in gold jewellery exports. Figure 1 Exports (USDm) 6, 5,, 3, 2, 1, Gold jewellery (LHS) Total exports (RHS) Jan 11 Jun 11 Nov 11 Apr 12 Sep 12 Feb 13 Jul 13 Dec 13 May 1 Oct 1 Mar 15 Source: Gems & Jewellery Export Promotion Council, Ind-Ra CPD (LHS) Linear (Total exports (RHS)) (USDm) 7, 6, 5,, 3, 2, 1, Rough diamond imports registered a fall of 9% yoy in FY15. Importers have cut production on concerns over falling processing margins. Exports to the UAE and Hong Kong grew at a higher CAGR than the overall CAGR for exports of 13% over FY- FY1. The US remained the top three export destinations for gems and jewellery over the same period. The rebound in jewellery exports may be attributed to an improvement in metal availability after a slew of policy measures by the government including scrapping of :2 scheme and reintroduction of gold on lease for jewellers in November 21. CPD exports fell amid weak global demand accentuated by a downturn in China and political unrest in the Middle East. Demand from Key Markets to Shape Exporters Performance for FY16 Demand for gems and jewellery has broadly followed the GDP trends of the country, a reflection of the disposable income of consumers. According to Bloomberg estimates, GDP growth rate for the US and UAE in 215 are likely to be sustained at 21 levels (2.% and 3.6%, respectively) and China to register a decline to 7% from 7.% in 21. Figure 2 Exports of Gems & Jewellery (USDm) 25, 2, FY FY9 FY1 FY11 FY12 FY13 FY1 CAGR 2% 15, 1, CAGR 1% CAGR % CAGR 6% CAGR 13% 5, UAE Hong Kong/China US Europe Others Source: RBI, Ind-Ra There are mixed signals from the demand drivers of key export regions, and hence Ind-Ra expects overall export demand for gems and jewellery in USD terms for FY16 to remain muted and register single digit growth rates. June 215 2

3 Figure 3 Real GDP Growth Rates 12 UAE Hong Kong China US Euro Zone India F 216F 217F Source: Bloomberg, Ind-Ra Growth in Value of Export to be Restricted Ind-Ra expects the price of gold to further decline by 1% to INR2,/1gm- INR2,5/1gm in the event of a US interest rate hike. CPD prices are also likely to remain under pressure on account of muted demand for luxury products in key markets and higher inventory levels with traders. Credit Availability to Remain a Constraint, More So for Exporters Overall gross bank credit grew at 2.1% between March-December 21 (March-December 213:.1%) while credit to the gems and jewellery sector grew at.% (.1%), reflecting a decrease in the credit appetite for this sector. Closure of a major diamond trade financing bank in Europe has also led to a credit crunch for the sector. Such constraints are likely to put pressure on export volumes. Revenue growth for exporters in FY15 was broadly in line with the agency s expectation as stated in 21 Outlook: Gems and Jewellery. Operating Performance of Exporters Moderate Revenue Growth Revenue growth for exporters is likely to remain between 3%-5% in FY16 due to constraints in demand and lower prices of gold and CPD. In FY15, overall revenue growth was moderate in the range of %-6%, in line with the revenue growth expectation in the last year s outlook. Like in FY15, the companies present in the gold jewellery exports business are expected to show higher revenue growth rates (FY15: 9%-12%) than those in diamond exports. We have considered a sample set of key listed exporters (five) and retailers (six). The analysis is based on the average for these players adjusted for any outliers. We have assumed that these players are broadly representative of the industry performance and trends Figure Revenue of Representative Exporters Asian Star (LHS) Tara Jewels (LHS) (INRm) Shrenuj & Co. (RHS), Renaissance Jewellery (LHS) Rajesh Exports (RHS) 6, 3, 5, 2, 3, 1, 15, Note: Consolidated financial statements have been considered. The above is based on financial year ending March 31. Tara Jewels is available FY9 onwards. June 215 3

4 Margin to Stabilise in FY16 EBITDA margins are likely to improve in the range of 3.5%-% for FY16 as margins for both the CPD and gold segments improve. Rough diamond prices, after increasing in 1HFY15, are likely to moderate in FY16 with a temporary reduction of financing options given the closure of a major diamond trade financing bank in Europe. Such lower prices might translate into higher margins for diamond exporters to the extent CPD prices remain stable, backed by consumer demand. The removal of import curbs and the associated reduction in local gold premiums as well as in raw material cost are likely to improve margins in the gold jewellery export segment. In FY15, overall EBITDA margin contracted to around 3%. Diamond exporters witnessed a contraction of processing margins as rough diamond prices remained high in 1HFY15. Gold jewellery exporters were hurt on both sides as limited availability of gold due to import restrictions increased the premium for procurement of gold while falling international gold prices led to a fall in absolute making charges/gross margin for gold jewellery. Figure 5 EBITDA Margins of Representative Exporters 12 Rajesh Exports Shrenuj & Co. Asian Star Renaissance Jewellery Tara Jewels Note: Consolidated financial statements have been considered. Credit Metrics of Exporters to Remain Stable In FY16, interest coverage ratio is likely to stabilise at 3.x levels for exporters. The reinstatement of gold on lease scheme will help lower interest cost (cost for gold on lease is 5%-7% and on working capital loan is 12%-1%). Interest cover improved slightly in FY15 to 2.5x (FY1: 2.2x) as interest cost declined in 2HFY15 due to the reinstatement of gold on lease scheme in November 21. Full benefits are likely in FY16. Figure 6 EBITDA to Interest Cover of Representative Exporters (x times) 6 Rajesh Exports Shrenuj & Co. Asian Star Renaissance Jewellery Tara Jewels Note: Consolidated financial statements have been considered. June 215

5 1Q7 2Q7 3Q7 Q7 1Q 2Q 3Q Q 1Q9 2Q9 3Q9 Q9 1Q1 2Q1 3Q1 Q1 1Q11 2Q11 3Q11 Q11 1Q12 2Q12 3Q12 Q12 1Q13 2Q13 3Q13 Q13 1Q1 2Q1 3Q1 Q1 1Q15 Corporates Domestic Players to Perform better than Exporters According to Indian Brand Equity Foundation s estimates, India s domestic gems and jewellery industry was valued at USD.5bn in 213. Gold jewellery and medallions accounted for 75% of the market while diamond and other jewellery accounts for the balance. Overall consumer demand for gold fell 16% yoy in 21 to 7 tonnes led by a sharp fall in demand for gold coins and medallions (6%). This was because of lower investment demand due to a fall in prices of gold and better returns from other asset classes (equity). Gold exchange traded funds continued to record outflows and have been at their lowest level (assets under management of USD1.5bn) since 211. Figure 7 India: Consumer Demand of Gold (tons) Jewellery (LHS) Total bar & coin (LHS) Average gold price (RHS) (INR/1gm) 25, 2 3, , 5 1, -5 Source: WCG, Bloomberg, Ind-Ra Demand for jewellery fell by 2% (by volume) despite a severe fall in gold imports as gold was made available through unofficial channels, pointing at healthy underlying demand. The World Gold Council expects gold available through unofficial channels to have been around 175 tonnes in 21. Restrictive government policies such as :2 scheme, a hike in custom duty to 1% and discontinuation of gold lease scheme led to a fall in imports by 5% in FY1. Figure Trends in Gold Imports (USDm) Gold imports (LHS) Growth rate (RHS) 15, , 75 9, , , Source: GJPEC, Ind-Ra Consumption Demand Key Amid Lacklustre Investment Demand Ind-Ra expects domestic jewellery demand to improve in FY16, led primarily by cultural underpinnings in India, a recovery in economic conditions (estimated GDP growth at 7.5% in 215) and an improvement in demand from tier 2 / tier 3 cities aided by the growing penetration of the organised sector. Furthermore, an expected moderation in gold prices between INR27,5/1gm-INR25,5/1gm will further boost the consumption. Gold Monetisation Scheme will allow household/institutions to deposit gold and earn interest on the same. Also, it will serve as another channel for jewellers to obtain loan in their metal accounts. Success in Gold Monetisation Scheme May Further Ease Regulatory Restrictions The government announced the gold monetisation scheme in 215 to reduce imports and utilise the gold lying idle with households. Successful implementation of this scheme is likely to have a favourable impact on the industry. However, the magnitude of impact will vary with the quantity of gold monetised and its significance in meeting the overall demand in the industry. June 215 5

6 Operating Performance of Retailers Moderate Revenue Growth Revenue growth for retailers in FY16 is likely to be slightly higher between 1%-12% (FY15: %-1%) as supply side constraints have eased with the removal of restrictive government policies. Store additions in tier 2 and tier 3 cities will drive revenue growth of organised players as customers have shifted preference towards large retailers as also seen in FY15. Focus on higher ticket diamond and studded jewellery sales will also aid revenue growth. Besides the underlying consumption demand, the redemption of jewellery finance schemes mostly in the form of jewellery sales to comply with the change in guidelines under Companies Act 213 provided a short-term boost to the top line of players in FY15. Figure 9 Revenue of Representative Retailers (INRm) 25, 2, 15, 1, 5, Note: Consolidated financial statements have been considered. The above is based on financial year ending March 31. PC Jewellers and TBZ data available FY12 and FY1 onwards respectively. Margin to Improve in FY16 TBZ (LHS) Gitanjali Gems (RHS) Shree Ganesh Jewellery House (RHS) Thangmayil Jewellery (LHS) Titan (RHS) PC Jewellers (RHS) 2, 16, 12,,, For FY16, EBITDA margins are likely to improve to 9%-12% as players focus on higher-margin products such as diamond-studded jewellery. Furthermore, ease of supply side restrictions and the resulting moderation of local premium on gold will translate into a lower raw material cost and better gross margins on gold jewellery. Reinstatement of gold on lease scheme will also protect the EBITDA margins as the price risk on inventory reduces. However, such improvement in margins will continue to be constrained by increasing promotional discounts, administration cost and marketing spends due to store expansions. In FY15, domestic retailers maintained EBITDA margins at 7%-1%, despite regulatory hurdles creating upward pressure on raw material cost in 1HFY15. June 215 6

7 Figure 1 EBITDA Margins of Retailers Credit Metrics to Improve TBZ (LHS) Gitanjali Gems (LHS) Shree Ganesh Jewellery House (RHS) Note: Consolidated financial statements have been considered. Thangmayil Jewellery (LHS) Titan (RHS) PC Jewellers (RHS) Interest coverage ratio is likely to further improve and stabilise at 3x-3.5x in FY16 (FY15: 2.5x; FY1: 1.3x). FY16 will be the first full year of operations after the gold on lease scheme is made available to these players again. Hence, we will see the full benefit of interest cost reduction in FY16, provided players do not go for an aggressive debt-funded expansion strategy. Interest cover has improved slightly in FY15 as inventory funding through short-term debt decreased with the availability of gold on lease from November Figure 11 EBITDA to Interest Cover of Retailers (x times) TBZ (LHS) Gitanjali Gems (LHS) PC Jewellers (LHS) Note: Consolidated financial statements have been considered. Thangmayil Jewellery (LHS) Shree Ganesh Jewellery House (LHS) Titan (RHS) June 215 7

8 Appendix 1 Figure 12 Issuer Ratings Issuer Rating/Outlook (current) 21 BC Sen & Company Limited IND BBB+ /Stable/ IND A2+ IND BBB+ /Stable/ IND A2+ Arena Lifestyle Pvt Ltd IND BB /Stable IND BB /Stable/ IND A+ Karan Kothari Jewellers Pvt. Ltd. IND BB- /Stable/ IND A+ IND B+/Stable/ IND A SRS Limited IND A- /Stable/ IND A2+ IND BBB/Positive/ IND A3+ Mani Exports IND BB /Stable/ IND A+ IND BB- /Stable/ IND A+ Om Anand Exports IND A IND A MK IND A IND A Jodhani Exports IND A+ IND A+ Patdiam Jewels IND A+ IND A+ Parin Gems IND BB- / IND A+ IND B+ /Stable/ IND A Delta Jewellers Pvt Ltd IND BB- / IND A+ - Grace Suppliers Private Limited IND BB- /Stable/ IND A+ IND B+/Stable/ IND A Golkunda Diamond & Jewellery IND BB+ /Stable/ IND A+ IND BB+ /Stable and IND A+ Fine Jewellery Manufacturing Ltd IND BB /Stable/ IND A+ - P.K. Jewellery House IND B /Stable/ IND A - Shital Gems Pvt Ltd IND B+ /Stable/ IND A - Suhag Gems and Jewels (India) Pvt Ltd IND BB / Stable/ IND A+ - Source: Ind-Ra June 215

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