Titan Industries: Hold

Shareholders can continue to hold the stock of Titan Industries (Titan). The stock has been re-rated in the last three months, appreciating about 30 per cent on the back of a better-than-expected earnings performance.

Although its has cooled off from its highs, the stock (at Rs 1,550) still trades at a high valuation of about 30 times its 2008-09 earnings per share.

A strong branded presence, scope for tie-ups with international brands for retailing of watches and other accessories and forays into untapped, high-growth segments are among the factors that could ensure that the stock remains richly valued. In the near-term, the onset of the festival season and the expansion of retail outlets is likely to translate into strong revenue growth.

Investors can use steep declines linked to market weakness to buy into the stock. However, further rise in gold prices, especially amid a stable or declining rupee environment, could curb demand growth in the jewellery segment, which now leads revenue growth. This is a key risk to earnings estimates.

Clocking strong growth

Titan Industries has, over the past year, entered into high-growth stage, with revenues expanding at 40-50 per cent. Provisioning for earlier losses of its international operations and margin pressures curtailed earnings growth till the last fiscal.

However, with such one-time expenses out of the way, profit growth is likely to catch up, led by volume growth in both its jewellery and watches categories.

The jewellery segment operates the "Tanishq" chain of retail outlets and recently launched "Gold Plus" chain of stores that aims at tapping the demand for gold in Tier-2 and Tier-3 cities.

The segment has grown at a rapid pace of 50 per cent over the last couple of years and now accounts for about 60 per cent of the turnover. Branded jewellery retailing is relatively untapped, leaving a lot of headroom for growth for Tanishq.

The watches segment, in which Titan is practically a household name, is also recording a strong double-digit growth rate of 15-20 per cent. While Titan focuses on the mid-priced segment with its "Titan" and "Fastrack" brands, it has brands straddling across price points, with "Sonata" penetrating the sub-Rs 1,000 category and "Xyls" and "Nebula" at the premium categories.

The luxury segment, which caters to a price range above Rs 10,000 and is the fastest growing, has till now been dominated by international Swiss brands.

But Titan, through its licensing arrangement with the Movado group, is now well placed to tap this segment through the marketing of premium brands such as "Tommy Hilfiger" and "Hugo Boss". Success in retailing Hugo Boss watches may see more international brands choosing to tie up with Titan for retailing of their brands. Luxury brands have so far limited their presence to posh hotels and upscale malls, allowing Titan to build its presence as a watch retailer.

Tapping new areas

Titan has also forayed into other untapped segments, with its precision engineering division, which caters to the automotive and aerospace sector, and the prescription eye wear segment.

The latter is a more recent move. Titan has opened a couple of pilot optical stores called "Titan Eye +", that will offer accurate eye tests and a range of frames and contact lenses. There are few players in this segment and Titan hopes to extend its expertise in design and fashion in watches to eyewear. Titan is also expanding into international markets. Having run into rough weather with the launch of its "Titan" brand of watches in the European market, the company is taking a more cautious approach to its US expansion.

It will be setting up a pilot "Tanishq" store in the US.

The launch of its jewellery in the international markets may find takers with the non-resident Indian diaspora. Tapping a broader clientele would, however, involve extensive brand-building efforts considering the competition in those segments and the market's lack of familiarity with Indian brands. However, these forays are unlikely to be significant contributors to revenues in the medium term.

Benign margins

Titan's earnings growth is likely to be led by volume growth in the watches and jewellery category. With an increasing share of the low-margin jewellery business, operating margins are likely to be contained at about 8-9 per cent levels.

A couple of aspects will have a bearing on operating margins in the coming quarters:

One, a sharp rise in the price of gold. Gold prices are already up 20 per cent this year, but only 8 per cent in rupee terms, thanks to the strong domestic currency. This may have limited the impact on demand for jewellery, which typically has an inverse relationship with gold prices.

The company passes on much of the price movements in gold to its customers. If the rally in gold continues, but the rupee remains at these levels or actually depreciates, volumes could take a hit.

There could be some impact of this in the September quarter, when gold prices in rupee terms rose 8 per cent. Coupled with the postponement of purchases to the festive season, the revenue growth in this segment is likely to be more sedate for the quarter.

Two, aggressive store rollout in the watches segment. This has already affected margins in April-June quarter. More than 50 "World of Titan" stores are to be opened by the end of the fiscal. It will take a while for these stores to break even.

Three, higher advertising spends. Titan's operating margins in the first quarter of the fiscal would have declined had it not been for the sharp slash in advertising spends. Advertising as a proportion of sales stood at 9 per cent in FY-07.

It is likely to remain a significant expenditure for the company, as it introduces new ranges, enters new segments and steps up its brand-building effort to take on competition from entrants such as Rajesh Exports, Gitanjali Gems which also have plans for the domestic market.

Volume-led growth

Titan will have to focus on improving its product mix, such as increasing the share of premium and mid-priced watch brands and studded jewellery to tackle the above pressures on margins.

For now, however, the company appears focussed at driving volume growth to boost profits. The strategy has worked well so far, as borne out by the high returns generated on its capital employed. But it exposes the company to changes in the demand environment, arising out of lower affordability or increasing competition.