Exporters are likely to register muted revenue growth of 3%-5% as global demand is exhibiting mixed signals, with the US and China showing improving and declining trends, respectively. Average industry EBITDA margins could increase by 100bp-200bp as processing margins improve with a moderation in rough diamond prices. This will be led by a temporary reduction of financing options due to closure of a major diamond trade financing bank in Europe.
Retailers might register a recovery in revenue growth between 10%-12%, aided by an increase in consumption demand and a shift in consumer preference towards organised retailers. Store additions in tier II and tier III cities will further provide support to the expected revenue growth. EBITDA margins are likely to improve 100bp-300bp with the easing of supply side restrictions such as removal of 80:20 scheme and reinstatement of gold lease scheme in November 2014. Also, the resultant moderation of local premium rated on gold will translate into better gross margin on gold jewellery.
The reinstatement of gold on lease scheme will lower the price risk on inventory to the extent inventory is sourced through this channel. A focus on higher margin diamond jewellery sales will further support EBITDA margins. However, the improvement will continue to be constrained by increasing promotional expenses and administration costs due to store expansions.
Overall, the credit profile of industry players is likely to remain stable. We expect interest coverage ratio to be 2.5x-3x (FY15: 2.0x-2.5x) in FY16. Sourcing under the gold lease scheme will reduce average debt levels as well as borrowing costs for industry players, more so for organised retailers.
Ind-Ra expects credit availability to remain a constraining factor for the sector as banks have recently become selective in the light of some big ticket defaults and restructuring in the industry. Such defaults to an extent may have been driven by idiosyncratic factors specific to the concerned corporates and may not be squarely attributed to sector specific issues. However, the tightening of credit could affect export volumes.
OUTLOOK SENSITIVITIES
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Discretionary Spending: The key demand driver for the industry is the discretionary spending of end-consumers. Any deterioration in spending ability, driven by a 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.
Government Regulations: The government implemented several positive policy changes for the sector in FY15 such as the abolition of 80:20 scheme. Any further positive action by the government such as a reduction of custom duty on imports from present 10% will aid the sector.
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