Sparkle is in brands - Titan Industries : Hold

In the light of high valuations and a possible squeeze in demand, investors can avoid buying into the stock at current levels.

The stock of Titan Industries has charted a steady journey upward, undeterred by market gyrations. The company's marketing push, its focus on diamond jewellery paying off, and the purchasing power of the Indian consumer, have led to strong earnings growth.

However, positive consumer sentiment is likely to be dampened by inflation eating into discretionary spends and spiralling prices of gold and diamond putting off purchases.

At Rs 228, the stock of Titan Industries trades at a trailing 12-month valuation of 41 times. Investors can retain their holdings in the stock. The company's advantage lies in its nationwide retail reach, and quality brands in a fragmented market. That said, in the light of high valuations and a possible squeeze in demand in the coming quarters, investors are advised against buying into the stock at the current levels.

Wide market presence

Titan has a host of factors in its favour. It has strong national brands in its three key segments — jewellery, watches and eyewear. With brands straddling multiple price points, Titan addresses all consumer brackets from low-end to premium. Branded markets, whether in watches or jewellery, are yet nascent in India, and Titan's brands are among the few national ones.

It also has licensed international brands. The company has an edge over budding branded jewellers with its far-flung retail footprint, using a combination of dealers and exclusive stores. Owned stores number 696, up from the 624 in January and dealer presence is in over 10,000 outlets. In addition, Titan watches are sold overseas as well, in growth markets such as Vietnam and South Africa. Funding expansion will not be a hurdle in the current situation of tight liquidity, with its low debt:equity of 0.08 times and strong cash flows.

Titan also expanded the watch manufacturing capacities and modernised units in FY-11. It is taking steps towards tying up directly with suppliers (sightholder status) for long-term diamond supply, besides buying more of rough diamonds to process them in-house to help control costs.

Jewellery demand pressures

But even as Titan is in a better position than most peers to manage growth, a few factors suggest a cautionary approach. The share of jewellery in revenues jumped to 75 per cent in FY-11 from 68 per cent in FY-08 at the expense of watches.

The share rose further to 80 per cent in the June '11 quarter. The jewellery segment is further split between diamond and gold jewellery. In both segments, Titan has strong national brands.

For the past year, Titan stepped up focus on diamond jewellery to counter demand pressures from rising gold prices. Diamond jewellery accounted for over 25 per cent of sales. But diamonds are mirroring gold in a relentless uptick in prices — polished diamond prices have increased over 15 per cent from January alone and have more than doubled in the past 18 months. The shift away from gold could, therefore, not work as well as it did in the past.

Another niggling factor is the susceptibility of the middle-class consumer to rising inflation, leaving lesser room for discretionary spends. Titan's mass-market offering, GoldPlus, showed a volume decline of 14 per cent in FY-11.

In the premium segment, Tanishq faces competition from other national brands, such as Nakshatra, Orra and Asmi, and foreign brands as well. To remain competitive across segments, the management has indicated, in its annual report, that it is willing to sacrifice margins.

For instance, it has upped the exchange rate for diamond jewellery. Besides, jewellery sales could be dampened by the requirement of producing the PAN card for transactions of over Rs 5 lakh. The management also reported a decline in footfalls in jewellery and watches segments. A decreasing share of watches could pressure margins. Watches typically give operating margins of 13-15 per cent while jewellery offers 6-8 per cent. The eyewear and precision engineering segment, which make up 4 per cent of revenues, are yet to turn profitable.

Strong earnings growth

Revenues have grown at a compounded annual rate of 30 per cent over the past three years to Rs 6,673 crore in FY-11. Net profits grew 41 per cent to Rs 434 crore in the same period.

Operating margins for FY-11 improved a shade to 8.9 per cent from the 8.3 per cent in FY-10. Input costs, as a proportion to sales, increased 2 percentage points to 73 per cent in FY-11. In the last fiscal alone, cost of sourcing polished diamonds ballooned 90 per cent. However, controls in cost heads of manufacturing helped maintain margins. A decline of 68 per cent and 42 per cent in interest and depreciation resulted in net profit margins improving to 6.1 per cent in FY-11 against the 5 per cent in FY-10.

The June '11 quarter saw a further rise in raw material costs, with proportion to sales rising to 75 per cent. The company reduced advertising burden to maintain margins at 9 per cent, but with competition abounding and strategies to push sales in the face of subdued demand, promotion costs may see some rise.

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