PC Jeweller Ltd IPO Review by Naman Sec (Apply)

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Review By Naman Securities and Finance Pvt. Ltd on December 10, 2012

PC Jewellers, an integrated player with an established brand in the north, has come out with an IPO to raise Rs 564-609 crs, primarily for expanding its retail presence in the western and southern parts of India. The price band for the issue which opens today, has been fixed at Rs 125-135 per share. The promoter has offered a discount of Rs 5 at the final price to retail investors, who can subscribe to 35% of the net issue. In this post, I evaluate the firm's fundamentals and valuation, culminating as always with a subscribe/avoid opinion.

• PC Jewellers earned ~67% from domestic sales and the balance from exports in FY12. It exports gold and diamond jewellery to distributors in Hong Kong and to wholesale customers in Dubai. Within domestic sales, its revenues is concentrated mainly in the Delhi/NCR regions. In FY12, 8 showrooms in Delhi together accounted for 61% of domestic revenues and 41% to the overall revenues. The company set up two manufacturing facilities in Noida SEZ for export sales - the first commenced operations in 2007 and the second in 2011. Interestingly, the company purchased a factory building at Noida SEZ from PC Jewellers (Exports) for Rs 4 crs in April, 2011. To give a brief background, PC Jewellers (Exports), is a group company engaged in the export of gold and diamond jewellery, thereby competing with PC Jewellers' export business. In September 2011, the partners in PC Jewellers (Exports) gave a confirmation that the partnership is being dissolved and that it will not undertake any new business. The dissolution process still remains to be completed, however media reports suggest that no business has been carried out by PC Jewellers (Exports) from December 2011 onwards, which may also be inferred from the 30% y-o-y drop in its FY12 revenues.
• In terms of product offerings, the management has been quick in identifying the shift in consumer preferences towards diamond jewellery -  the share of diamond jewellery revenues has increased from ~12% in FY10 to ~22% of total revenues as of September 2012. Continued focus on expanding the diamond jewellery segment will lead to expansion in operating margins due to the higher margins in the diamond jewellery business. For instance, the diamond jewellery segment earns gross margins of 26-28% as compared to 9-10% in the gold jewellery segment. Consequently, PC Jewellers EBITDA margin has expanded from 10% in FY10 to 12.6% in the first half of 2012-13.
• PC Jewellers has grown at a robust pace in the last few years - it has posted a 3 year (2009-12) CAGR of 70% and 130% in revenues and net profits respectively. This is primarily owing to the expansion in retail network - from 5 showrooms and 31,000 sq. feet in fiscal 2009 to 30 showrooms and 1,65,000 sq. feet in H1FY13. The company plans to open 20 more showrooms spread over the current and the next fiscal, primarily in the western and southern regions. Revenues per average store of PC Jewellers in the last three years has ranged between Rs 130 crs to Rs 150 crs per annum. Assuming a total store count of 35 stores at the end of FY13, revenues per average store of Rs 135 crs in FY13 along with H1FY13 actual revenues, we can safely assume that the company will clock a revenue growth of ~ 30-32% in FY13, though slower compared to its historic growth, but still healthy relative to the present conditions of subdued economic growth in the country. Since the company has never in the past added 20 stores in two years, I have assumed the addition of stores to be spread over three years. Further, since these stores are in areas new to the management, it will take time for them to turn as successful as the flagship stores in Delhi. Since the issue funds are to be deployed towards the opening of these new stores in phases over the next two years, the RoE post issue will remain depressed till FY14. The other risk is cost escalation; the estimated requirement of funds could be 10-12% higher since the actual deployment is still one-two years away.
• Jewellery manufacturing is a labour and working capital intensive business. PC Jewellers has a cash conversion cycle of ~80 days. It sources gold through canalizing agencies or international bullion suppliers under the gold loan schemes. Under the gold loan scheme, the price of gold purchased is fixed within the applicable credit period on the basis of prevailing gold rates on sale to customers, thereby providing a hedge from risks associated with gold price fluctuations through the time of procuring the raw material and selling the finished product to the customers. However, this cushion is not available on cut and polished diamond sourced from diamond traders in India, Hong Kong and Dubai. The purchase of diamonds is made on fixed payment basis i.e. the price and credit period is fixed at the time of purchase. Hence, the company is exposed to upside/downside risks from diamond price fluctuations between procurement and sale in the diamond jewelry business. This is pertinent to note since diamond jewellery is the faster growing segment and also because diamond prices are prone to wide swings.
• The company leases some of its showrooms from the promoter family enjoying rentals, which are lower than market rates. Switch to arms length lease terms in future could lead to a minor rise in costs.
• An instance of weak corporate governance emerges in the company's remuneration policies. The top 3 executives, who are also the promoters draw 94% of the total remuneration drawn by the key managerial personnel! Their combined remuneration comprised about 22% of the company's 'Salaries, wages and bonus' line item in FY12. Moreover, Mr. Balram Garg has given himself a 33% salary hike for FY13 taking his annual remuneration to Rs. 6 crs!

Valuation:

 At the upper end of the price band of Rs 130 (post discount of Rs 5 to retail investors), PC Jewellers' implied PE multiple on FY13E EPS of Rs 21.2 is 6.1x. Titan trades at high multiples in the range of 30-40x. While Titan is a vastly stronger player with a diversified portfolio and strong brands, TBZ in our view is itself overvalued at 23x FY13E. Gitanjali is trading at 7.5x on FY13E EPS. I have calculated the PE multiple using the 2 weeks average price for Gitanjali since the stock price has run up in the last two-three trading days following allotment of fully convertible debentures to DB Corp Ltd. Another comparable company is Thangamayil Jewellery Ltd.

 Valuation attractive, expect 15% upside

 Gitanjali is about 3 times the size of PC Jewellers in revenue terms; however PC Jewellers is growing at a significantly faster pace — 3 year revenue and PAT CAGR of 70% and 130% respectively for PC Jewellers as compared to 35% and 47% for Gitanjali Gems. Since, the company is in an expansionary phase the growth momentum, albeit at a slower pace, can be expected to continue over the next 2-3 years.

 Gitanjali has reported an average 3 year RoE of 12.3% as compared to 46% for PC Jewellers. Though PC Jewellers' RoE will likely get suppressed post issue, it will improve by FY14-15 as the benefits of retail expansion accrue. PC Jewelers issue price (at upper cut-off to retail) implies a discount of 30% to Gitanjali's PEG multiple of 0.38x, which appears attractive. Though PC Jewellers is growing at the faster rate than its peers, it faces substantial risk as it enters the western and southern India, both new geographies with highly competitive markets and with consumer tastes less familiar to PC Jewellers.