Ind-Ra expects retailers to fare well underpinned by a sustainable domestic demand, shifting preference towards branded jewellery, and fading regulatory headwinds. Conversely, exporters might face temporary headwinds with slowing Chinese demand for diamond jewellery and are likely to have limited headroom to withstand further pressure on margins due to divergence in rough and cut and polished diamond (CPD) prices.
Ind-Ra expects domestic jewellery demand to remain robust and grow at 3%-5% in 2016 to 670-685MT because such demand remained steady at 600-670MT over 2010-2015 (source: World Gold Council), despite gold price volatility on the back of wedding related purchases. The agency believes that the excise duty hike announced in the union budget and mandatory pan card requirements for purchases above INR0.2m will marginally impact the demand in the near term. Government gold schemes such as gold bond scheme and gold monetisation scheme are likely to have a neutral to positive impact on retailers in the medium term as cost savings from an increase in domestic gold supply will be offset by lower gold sales volumes due to diversion of part of volumes to GBS.
The agency expects retailers' credit metrics to improve in FY16 as resumption of gold metal loans will lead to a reduction of overall borrowings and interest costs and also protect EBITDA margins against fluctuations in gold prices. Credit metrics for FY17 are likely to remain at FY16 levels as any improvement in EBITDA will be offset by higher debt requirements for funding store additions.
Indian CPD exports fell around 15% yoy to USD14.7bn during the nine months ended December 2015. The diamond industry struggled with inventory accumulation across the value chain in 2015 as the slowdown in Chinese demand for diamond jewellery (6% in 2014 against CAGR of 14% over 2010-2014) created a ripple effect on the entire chain. Mid-stream players were the most affected as reduced demand led to a fall in CPD prices, while slow moving inventory along with drying up of bank finance compelled them to unload inventory. This pushed CPD prices further down and led to continued profitability erosion in this segment.
Although rough producers lowered rough prices by around 17% in 2015, most of the rough price reduction (about 15%) happened towards 2H15 and was in response to midstream refusing to buy unprofitable roughs. Since then, rough producers have guided down rough production for 2016 to maintain supply and allowed deferment of sights and flexibility in payment terms to support midstream players. However, rough price index remains higher than CPD price index and an improvement in profitability is unlikely in the near term.
Additionally, the industry continues to face the risk of penetration of undisclosed synthetic diamonds and advent of lab-grown roughs, but the short-term impact may be limited.
Ind-Ra expects CPD players' credit profile to remain stretched due to restricted revenue growth, stagnant and low EBITDA margins and higher working capital debt to fund an elongated operating cycle. Most of these players have nearly fully used working capital lines and any further stretch in export bill collection can increase liquidity pressure.
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OUTLOOK SENSITIVITIES
Reintroduction of any measures to curb gold imports or restoration of any excise duty is likely to have a negative impact on the sector. Also, any severe fall in supply of mined gold globally can lead to higher gold prices and may dampen gold consumption, leading Ind-Ra to change its outlook to negative for the sector.
Recovery in Chinese demand, a buoyant US demand for diamond jewellery, and an improvement in CPD prices relative to rough prices are likely to have a positive impact on exporters.
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