Gem jewellery stocks Opportunities Galore For Value Investors

In the wake of the recent scam that has jolted the gem and jewellery (G&J)   sector, two questions are plaguing the minds of stock market investors. First, how deeply are the banks exposed to the G&J sector? Second, can the G&J sector still glitter in the near future? Tanay Loya finds out ...

Sector Overview Over the years, the G&J sector has gained prominence in the country on the back of its dual utility of improving aesthetics as well as providing a reliable investment value. The G&J market comprises of four major segments: diamond-studded jewellery, gold jewellery, silver jewellery and precious and semi-precious gemstones and its jewellery.

India is relatively smaller market for the diamond-studded jewellery with about 7 per cent market share. However, it is a key market for gold jewellery, constituting about 27 per cent of the global gold jewellery market. A major chunk of gold jewellery manufactured in India is for domestic consumption, whereas a major portion of polished diamonds or finished diamond jewellery is exported.

The southern Indian states account for about 37 per cent of the country's total gold demand, followed by the western region with about 32 per cent, northern region with about 18 per cent and eastern region with about 13 per cent of the total demand. The demand for diamond-studded jewellery in India remains higher in the western and northern regions as compared with the southern and eastern regions, which are predominantly gold jewellery consuming markets.

The sector provides employment to over 2.5 million people and is home to more than 500,000 players, with the majority being small players. Also, the G&J sector contributes 6 to 7 per cent to our GDP. Based on the potential for growth, the industry has been declared as a focus area for export promotion. India is the largest exporter of gems and jewellery and the industry plays a vital role in terms of foreign exchange earnings with UAE, US, Russia, Singapore, Hong Kong, Latin America and China being the biggest importers.

According to a World Gold Council report, India's gold demand grew by 9.1 per cent to 727 tonnes in 2017 due to low prices coinciding with Dhanteras, positive economic backdrop and improved consumer sentiment, especially in rural areas. This happened when global demand for gold was at its lowest since 2009, as weaker fund investments outstripped a bump in jewellery consumption.

Last 5 quarters performance of G&J stocks 

For the purpose of evaluation, we have considered the performance of 15 companies from the G&J sector in the last five quarters. The net sales of the sector declined 29.8 per cent year-on-year for the December 2017 quarter. It is important to note that this is on a low base, when net sales had increased marginally during the demonetisation quarter.

The operating profit improved marginally by 2.26 per cent YoY and decreased 2.66 per cent QoQ. The profit after tax for the sector was not any better. On a year-on-year basis, PAT decreased 40.66 per cent, whereas on a quarter-on-quarter basis, it declined 12.72 per cent. The sector has been under pressure as working capital was blocked owing to refund delays during the implementation of the goods and services tax. A more or less consistent decline in both sales and profitability in the last five quarters can be observed.

In sync with its sales and profitability numbers, the average one year return of the stocks in our sample was -11.78 per cent. In the light of the recent scams, the sector wiped out over 50 per cent of the investors' wealth on a YTD basis. In the last three years, the sector grew 14.63 per cent annually, whereas in the last 5 years, the sector reported 22.25 per cent annual growth.

Ongoing Turmoil The act of ‘loot and scoot' unleashed by diamond merchant Nirav Modi and Gitanjali Gems promoter Mehul Choksi, is expected to increase banks' NPAs from the G&J sector from 12 per cent to 30 per cent. PNB had extended guarantees to Nirav Modi and his associates to raise Rs.11,400 crore abroad without taking any guarantee. After the scam broke out, PNB filed complaints against Nirav Modi and his associates, including Mehul Choksi, with the CBI.

 According to CARE Rating, the banking sector had a total loan exposure of Rs.69,000 crore to the G&J sector as of December 2017 and its stressed assets accounted for 11.7 per cent. With the shutdown of these two companies, the money raised by them, amounting to Rs.16,000 to 17,000 crore, would take the overall gross NPA ratio for this sector to about 30 per cent. The shutdown of these two companies is also expected to pull down the diamond and jewellery foreign trade by six per cent next fiscal.

Just when everyone began to think that the problem was limited to PNB, the investors' sentiment was further dented by the alleged Rs.824 crore fraud by Chennai-based Kanishk Jewellers. Acting on a complaint lodged by State Bank of India, the CBI booked the promoters of the firm for defrauding at least 14 banks. In the midst of this, the country's diamond trade seems to have lost its sparkle.

India processes about a billion diamond pieces annually, amounting to $23 billion. Domestic consumption is about 7 per cent of the total diamond trade. Although, there may be a marginal drop in the domestic consumption post the Nirav Modi incident, the exports are expected to be unaffected. In February, India's import of rough diamonds showed a 9.26 per cent drop from a year ago period.

Interest Cover Interest cover, which measures the ease with which companies can pay their interest obligation, has also deteriorated to 1.7 times in the December 2017 quarter from 3.2 times in the same quarter last year. However, as the saying goes, every cloud has a silver lining. According to Kotak Institutional Equities, exposure of 18 banks' (12 public sector and 6 private sector banks) overall book to the G&J sector is only about 1 per cent. Nonetheless, the fact that interest cover for the sector has been deteriorating over time does not bode well for the sector, especially if banks turn overcautious and tighten liquidity to the sector.

Bankers' line of action The bank officials are now making frequent visits to the facilities of diamond exporters and traders for stocktaking and also to understand the trend in the global markets. Some banks are also said to be considering getting the stocks valued by independent experts before lending to the sector.

Some bankers have reservations about the efficacy of store audits, given the current IT infrastructure level in several jewellery firms. Also, not many firms have centralised inventory control. It is not practical for banks to do stock audit on a realistic basis by merely visiting stores and factories, since many big or medium sized retailers have over 100 stores across the country.

The inadequate number of independent assessors also serves as a big hindrance. The banks are expected to tighten their purse strings while lending to the sector. Although it may hurt the trade for some time, but in the long term, this will bring more transparency in the trade and only genuine players will survive. Also, the Gem & Jewellery Export Promotion Council (GJEPC) has decided to form a committee with senior bankers to find out how risk can be mitigated in diamond trade and to ensure that financing to the sector remains smooth.

Technical Analysis of G&J Stocks

Disappointing Union Budget 2018-19 had become the catalyst for the much-awaited correction in the Indian stock market from the all-time high levels. The sell-off by the long-term investors who would come under the ambit of the newly introduced LTCG tax for holdings after March 31, 2018, contributed to the fall. However, the biggest blow to the markets came in the wake of the disclosure of jewellery designer Nirav Modi's Rs.11400 crore PNB scam. Thereafter, the free fall in PSU banks and gem and jewellery stocks was inevitable.

Nirav Modi-family promoted Gitanjali Gems witnessed a blood bath after the news broke out and the stock has been falling consistently since then. As we always say, price discounts everything, Gitanjali Gems had cued a downfall by giving a multiple point upward sloping trendline breakdown at 61 levels on February 02 followed by a pullback and a retreat on February 14. Other stocks simply followed on cue.

Rajesh Exports, the top market cap jewellery stock witnessed a symmetric triangle breakdown on February 19, while P C Jewellers, the second largest company by market cap, witnessed a bearish pennant pattern breakdown on February 15. Additionally, the fall was supported by rising volumes. On the other hand, stocks such as Vaibhav Global, Thangamayil and Renaissance Jewellery are seen consolidating on the upside. Moreover, Titan Company, the only jewellery stock in BSE 500, has outperformed the benchmark indices and is looking strong on technical perspective.

In the present scenario, majority of gem and jewellery stocks are trading below their 200-day EMA, which is perceived to be the dividing line between a stock that is technically healthy and one that is technically weak and, thereby, going forward we do not see any immediate glitter in the G&J sector.

Conclusion It is important to differentiate between the current PNB-related fraud and the performance of the gem and jewellery sector in general, as the two are not related per se. The gem and jewellery sector can be seen to be going through a transformation phase. We do not expect any immediate glitter from the sector. However, value investors should be all ears since the stocks have largely corrected and are available at attractive valuations.