Bengaluru (By Evaluate Research): Rajesh Exports reported a stellar increase in revenues on a sequential QoQ and YoY basis while net profit growth was flat on YoY basis and in positive single digits on a sequential QoQ basis for the second quarter ended September 2019. Revenues for the second quarter came in at Rs.668 bn, up 25% YoY and 65% on a sequential QoQ basis. Revenue growth has shown sharp jump on a YoY and QoQ basis despite a slowdown in demand for gold in developed and emerging market economies, indicating sustained recovery since the beginning of the current financial year. Robust revenue growth indicates that demand continues to be strong with the strategy to focus on the sale of high margin products by the company. For the second quarter, EPS increased by 4.5% to Rs.10.69 vs. Rs.10.23 in Q1 FY2020, while net profit also increased by 4.5% from Rs.3 bn in Q1 FY2020 to Rs.3.2 bn in Q2 FY2020. The net profit growth was relatively subdued as compared to revenue growth due to an increase in raw material costs as a percentage of sales leading to decline in gross margins on a YoY and QoQ basis. Our conversations with CEO Rajesh Mehta suggest the company is on track to post sustained growth YoY and QoQ in both revenue and EPS for the current fiscal year ending 03/2020.
The absolute reduction in finance costs to nil as compared to Rs.1 bn in Q2 FY2019 was the primary reason for 5% increase in profitability despite a decline in gross margins on a YoY basis. As a reminder, Rajesh Exports remains a zero debt company. The finance costs were reported as zero on account of an adjustment of the interest cost in the COGS.
Within Rajesh Export’s home market in India, while reported official GDP growth has been robust [albeit slowing] at around 5%, unemployment remains at high levels, and the demand for luxury goods in particular, such as cars [both mass market as well as high-end], apartments and real estate, and gold/jewelry has all been subdued. Many of these markets haven’t really recovered from the Indian government’s demonetization and GST [goods and services tax] implementation a few years back. With a positive election outcome in May 2019, there is hope that demand would witness sustained recovery in India going forward, particularly during the ongoing festive and wedding seasons. During our conversations with management, they mentioned to us that the company is seeing strong demand for its higher margin value-added products and they expect robust sales growth going forward.
We maintain our FY2020 earnings forecast to Rs. 49.32 per share, a growth of 13% over the FY2019 earnings. The USA end market remains robust with strong consumer spending accompanying record low unemployment, while Europe has shown an uptick as evidenced by the export orders executed by the company in Q2 FY2020.
The company’s gross profit margin contracted to 0.7% in Q2 FY2020 from 1.07% in Q1 FY2020 and 1.06% in Q2 FY2019. The operating profit margin also contracted to 0.5% in Q2 FY2020 from 0.85% in Q1 FY2020 and 0.8% in Q2 FY2019. We believe most of this contraction is simply due to short-term working capital related finance costs [the company has no net debt] now being classified as COGS, rather than the prior classification as interest expense. The company continues to focus on the sales of higher margin products which are expected to enhance profitability for the company going forward. So we believe both gross and operating margins should gradually increase from today’s level.
Maintain Estimates and Price Target Rs. 900; 27% Upside
We maintain our FY2020 earnings estimates of Rs.49.32 per share on account of a continued growth in revenues and an increase in profitability. We maintain our one-year price target of Rs. 900 on the stock. Our price target represents an upside of approximately 27% from the current levels. Our 12- month price target on the stock is based on DCF methodology and backed by traditional P/E multiples as well. Please see detailed earnings and valuation model attached.
Rajesh Exports is the world’s largest refiner of gold and largest exporter of gold jewelry with a 40% market share in India. With over 30 years of operating history, the company is a low cost manufacturer due to economies of scale, and it derives 90% of its revenues from exports. The company is rapidly expanding in retail stores in India as well with 82 stores presently. The company is a prime beneficiary of secular growth in Indian and Asian gold and jewelry demand. Over the last five years, the company has recorded a CAGR of 29% in EPS and 44% in revenues.
Our DCF-based price is Rs. 871 which assumes a 13% WACC and a 3% terminal growth rate. Our price target implies a P/E multiple of 18x on our FY03/2020 EPS estimate of Rs. 49.32, and a P/E of 17x on our forward FY03/2021 estimate of Rs. 52.00. We continue to remain positive on the margin growth story based on the company’s strong execution seen over the last 18 months. While the company operates at a low level absolute of operating margins, a relatively small increase in margins can be highly accretive to the EPS.
Currently, the stock is trading at a P/E multiple of just 14x on our FY03/2020 EPS estimate, and a P/E of 13x on our forward FY03/2021 estimate, which is at a significant discount to its 5-year average P/E of 16x, as well as the overall Indian stock market where the benchmark NIFTY Index is trading at a trailing 25x P/E level.
Also, the stock is trading at a Price/Sales ratio of just 0.11 on our FY03/2020 revenue estimate and a P/S of 0.10x on our forward FY03/2021 estimate, which is at a significant discount to the trailing P/S ratio of 2.0x for the NIFTY Index.
