Gitanjali Gems: Buy

With a growing retail presence, strong brands, improving product mix and an international acquisition strategy that could strengthen its exports business, Gitanjali Gems is set to accelerate growth over the next two-three years.

At the current market price of Rs 412, the stock trades at about 16 times its likely FY-09 earnings per share. The valuation is at almost a 50 per cent discount to Titan Industries, which owns the Tanishq brand of jewellery retail stores. In terms of size, Gitanjali's domestic jewellery business is as large as Tanishq and the company has well-known brands such as Nakshatra, Gili and D'Damas in its bouquet. This makes it fairly well-placed to capitalise on buoyant domestic consumption trends as well. The risk of a slowdown in exports is somewhat mitigated by rapidly increasing share of the domestic business in overall revenues. Margins are also likely to improve with the increase in the export of higher value-added items. These factors may help the stock command improved valuations in the future. Gitanjali is also involved in the development of special economic zones for gems and jewellery and is now developing 200 acres of land in Hyderabad.

While this could lead to additional revenues from real estate, we have not factored payoffs from this business into our estimates. The company lacks a track record in this business, which is, in any case, fraught with risk. An investment in the stock can be considered with a two-year horizon.

Growing branded retail presence

Gitanjali Gems has a promising domestic retail business, which at Rs 1,432 crore, accounted for 40 per cent of its revenues in FY-07. The share of domestic revenues improved to nearly 50 per cent in the first half of FY-08. Gitanjali Gems retails gold and diamond jewellery under well-known brands such as Gili, Nakshatra and Asmi (the latter two have received marketing support from DTC till date). It also has a joint venture with the U.A.E-based retailer, Damas, to sell jewellery in India under the name D'Damas.

Recent developments point to an increasing focus on the domestic segment. One is its acquisition of the Nakshatra brand from Diamond Trading Company (DTC), the marketing arm of De Beers, for Rs 100 crore. This strengthens the company's grip on the market at a time when other traditional jewellery exporters are also getting into the branded retail business. Nakshatra is also a fairly mature brand now and this may mean marginal incremental investments on brand building from here on.

Gitanjali has also recently entered into a joint venture with an Italian fashion group, Mariella Burani, to introduce the latter's luxury and fashion products in India through a chain of stores. It struck a similar joint venture with Italian jewellery and watch retailer Morellato, which makes brands such as Cavalli, Moschino and Miss Sixty under licence, for distribution of watches and jewellery brands in India.

With a wider product range and potential to tap the premium end of the market through tie-ups with international retailers, Gitanjali is likely to make larger strides in the domestic retail space.

Improving product mix

While domestic retail is likely to drive revenue growth, operating margins are also likely to improve as the company's product mix shifts from low-margin cutting and polishing of diamonds (CPD) towards jewellery. Jewellery sales now account for 40 per cent of revenues. This share is likely to increase on the back of growing outsourcing of fabrication of jewellery to India. Gitanjali is also well-placed to capitalise on this trend with the acquisition of two retail chains in the US, Samuels Jewellers (100 stores) and Rogers (50 stores). The $100-million retailer, Samuels, will outsource 60 per cent of its fabrication work to Gitanjali.

While higher jewellery sales will increase on the one hand, the acquisitions provide direct access to the US market. A presence in retailing may give the company higher margins than would be the case with sales to international wholesalers.

The ability to command better prices as a result of these bodes well for profitability in the backdrop of higher prices of gold and precious stones. Gitanjali may also be better placed to withstand any slowdown in exports to the US compared to other gems and jewellery exporters.