Negative Outlook for India’s CPD Exporters: Ind-Ra

Mumbai: India Ratings and Research (Ind-Ra) has maintained a stable outlook on organised jewellery retailers and a negative outlook on cut and polished diamond (CPD) exporters for FY18.

As per World Gold Council (WGC), India’s gold jewellery demand fell sharply 22% yoy to reach a seven-year low in 2016 (522MT). The demand was impacted severely on account of various one-off events such as nationwide jewellers’ strikes in 1Q16 and severe liquidity crunch on account of the Government of India’s (GoI) demonetisation drive in 4Q16. Given the backdrop of four months of complete disruption on either the supply or demand side, Ind-Ra believes the fall in consumer demand was caused by idiosyncratic factors. However, the underlying jewellery demand still remains robust, given India’s strong macro-demographics and the consumer’s affinity towards gold. Hence, demand is likely to bounce back to above a five-year average of 600MT in 2017.

The GOI has been introducing regulatory changes over the last two years to control illicit trade practices prevalent in the jewellery industry, which is likely to benefit organised jewellers at the cost of unorganised retailers. Retailers face an overhang of the impending Goods and Services Tax Bill and a higher slab rate may turn out to be demand dampener particularly for the non-wedding segment.

Conversely, CPD exports increased 13% yoy to USD16.8 billion during 9MFY17, after declining for two consecutive years as per the Gems and Jewellery Export Promotion Council. This was because players across the value chain restocked following stock unloading and cautious inventory management in 2015 in response to a slowdown in the consumer demand for diamond jewellery in China and Hong Kong beginning 2H14. Although CPD exports have rebounded, the agency believes that midstream players continue to face headwinds for diamond jewellery demand owing to political and economic environment in key export markets. Additionally, the players continue to operate on thin margins and carry the inventory/price risk.

As expected by Ind-Ra, rough producers continued to lower rough prices by around 5% in 2016, while maintaining production close to 2015 levels (128 million carats) and extending additional flexible purchasing terms to CPD players. Ind-Ra expects rough prices to remain stable in 2017, unless CPD prices decline sharply due to muted demand and rough producers are forced to lower rough prices again.

Organised retailers are likely to have a limited impact of demonetisation in FY17 as reflected in revenue growth of around 8% yoy and improved EBITDA margins of 50bp to 10.2% in 9MFY17 based on Ind-Ra’s sample set. Favourable market dynamics and government regulations are likely to improve organised retailers’ revenue growth to double digits in FY18. EBITDA margins will improve with increasing share of diamond/studded jewellery in the sales mix On the other hand, Ind-Ra believes credit metrics for CPD exporters are likely to remain stretched in FY18 with EBITDA/interest coverage of 2.9x (FY17 Projected: 2.75x-3.0x), given muted revenue growth, low profitability margins, long working capital cycles and a high dependence on bank lines for inventory funding.