Titan: Short-term pain

Titan Industries’ stock lost close to three per cent on Wednesday after the company announced weak results for the December quarter.

The jewellery business (around 80 per cent of total revenues) disappointed, as volumes declined on an annual basis and the profit before interest and tax (PBIT) margin of the watch division was hit due to rupee depreciation, as the company imports most raw materials.

While long-term pro-spects remain healthy, the company is witnessing a demand slowdown. Also, the current stock valuation of 24.3 times its 2012-13 estimated earnings is not cheap. Kotak Institu-tional Equities Analyst Manoj Menon, in his post-results report, says: “We believe most of the positives are priced in. The opportunity for earnings upgrade is limited, with headwinds in 2012-13 for both demand conditions and margins.” Citigroup Global Markets analyst Aditya Mathur says in his report that the current valuation and volatile gold prices equate to an unfavourable risk-reward profile.
 

DOWNSIDE RISK TO MARGINS
In Rs crore	Q3’ FY12	FY12E	FY13E
Net sales	2,440	8,379	10,107
% chg (y-o-y)	25.0	28.2	20.6
Operating profit	213	762	944
% chg (y-o-y)	9.2	29.2	23.8
Net profit	164	571	710
% chg (y-o-y)	19.2	31.8	24.4
E: Estimates                                 Source: Company, Analysts estimates

Disappointing show
Though the sales growth of 25 per cent looks impressive, it is the lowest in six quarters. More important, the jewellery business, wherein volumes declined five per cent annually, partly due to a 38 per cent jump in average gold prices, disappointed.

More than prices, volatility drove consumers away despite the festive/wedding season in the quarter. The diamond price index is up 23 per cent.

On the other hand, the watches division reported an impressive sales growth of 17 per cent, led by a higher-than-expected volume growth of 11 per cent. The performance is impressive, given the overall economic slowdown, where demand for discretionary items like watches typically gets impacted. In fact, analysts say there is no sign of down-trading or deterioration in the sales mix, despite the slowdown.

The overall decline of 124 basis points in operating profit margin, to 8.7 per cent, was led by watches, as the division’s PBIT margin (12.5 per cent) dropped 581 basis points, thanks to the higher raw material costs (due to rupee depreciation) and the launch of a new brand, Helios.

Net profit margin, however, remained stable at seven per cent, as a two per cent decline in taxation and 60 per cent jump in other income compensated for a 38 per cent increase in depreciation, on the back of store expansion.

Outlook
Analysts expect the trend of a tapering top line growth to continue for a few more quarters, while they remain cautious on the margin front. Mathur says: “Volume growth could moderate and the scope for near-term margin expansion appears limited.” Volume growth for the jewellery business is likely to remain under pressure, but margins could get support from the healthy value growth, following structurally rising gold prices. While the management expects for a single-digit volume growth in watches, profitability is expected to improve sequentially, as the five-seven per cent price increase effected towards the end of December quarter will get fully reflected in the current quarter. However, on an annual basis, margins could see pressure on account of the expansion of Helios stores (25 by FY12-end).

In the long run, however, Titan continues to be one of the best stocks for playing the consumption theme, on the back of demand visibility (higher discretionary spends, rising penetration), market leadership in core businesses and healthy balance sheet (free cash flows).

The recent approval by the Cabinet for an amendment to the Bureau of Indian Standards Act (awaiting Parliament approval), which will make hallmarking compulsory for all jewellery items, will further help organised players like Titan.

Analysts believe it will enforce transparency in terms of gold quality and help the organised sector (now 10 per cent share) garner a large share of the market.

For now, stiff stock valuation (close to the five-year historic average of 25 times), amid volatile gold prices, has led the stock to lose some lustre. Analysts advise only long-term investors to accumulate the stock.