Kalyan Jewellers IPO: Shows potential

This a packed week for initial public offerings (IPOs) as many companies look to capitalise on prevailing bull market conditions. The latest in the list is Kalyan Jewellers. The company designs, manufactures and sells branded jewellery products including gold and diamond jewellery through a pan-India network of retail stores.

The size of the offer is ₹1,175 crore out of which ₹800 crore is fresh issue and the remaining ₹375 crore is an offer-for-sale (OFS) by promoter TS Kalyanaraman and PE investor, Highdell Investment, an affiliate of Warburg Pincus.

A stand out feature of Kalyan Jewellers is that a global PE player like Warburg Pincus has invested in the company and will continue to stay invested partly even after this IPO.

The proceeds from the fresh issue will be used to meet working capital requirements and general corporate purposes.

Business

India’s gold jewellery market is among the largest in the world. The key investment argument in favour of branded jewellery players in India, is the ongoing shift from the un-organised to organised sector and the consumer’s increasing preference for branded products. Covid-related disruptions and product quality worries have accelerated this trend. The share of organised players in jewellery has gone up from 6 per cent in 2007 to 32 per cent in 2020. Geographically, 40 per cent of the demand in India is from the southern states where Kalyan Jewellers first gained a toehold, before expanding its footprint pan-India.

While several branded jewellers listing on the Indian markets raised funds with the promise of acquiring a pan-India presence, they’ve remained regional players at most. Kalyan, after Titan Company, appears to have succeeded at this geographical diversification bid with 107 stores across 21 states. Over the past five years, the company has expanded its presence by increasing the number of showrooms from 77 in March 2015 to 137 in December 2020. Out of this, 30 are in the middle-east region. The company derives about a fourth of its revenues from GCC or Gulf markets with owned stores. The company also has an online presence, though the revenue from this stream is marginal.

Strategy

In terms of business strategy, a key feature that distinguishes Kalyan from others, even Titan, is its ‘hyperlocal’ approach. Recognising that jewellery design and grammage preferences in India vary sharply across States and regions, Kalyan makes it a practise to customise each of its stores to local tastes through procurement from local artisans and contract manufacturing. It has opened neighbourhood stores in the name of ‘My Kalyan’ for better outreach.

Like other South-based jewellers, the company also offers purchase advance schemes through which buyers can make monthly payments against which they can buy gold once the tenure ends and this brings in about 30 per cent of revenues. While margins are quite cost sensitive, Kalyan seems to manage them through hedging, purchase advance programmes and schemes for exchange of old gold which bring in about a fourth of sales.

Compared to other retail businesses, gold jewellery is highly inventory-intensive which leads to high working capital requirements. Given their cost-plus pricing models, jewellers in India enjoy limited pricing power. They typically pass-through gold price increases or declines to consumers. As the category is quite price sensitive, this can lead to sharp variations in sales and revenues from year to year.

Covid, thankfully, has proved less disruptive to jewellery sales than initially feared, with players such as Titan reporting normalising sales in Q3 and actual year on year growth in the first two months of Q4. Kalyan’s focus on wedding jewellery may ensure quick normalisation of purchases, with added benefits from the shift to large-format branded showrooms.

Financials and valuation

While the offer has many positives and the branded jewellery market offers growth potential, a key point to note is Kalyan’s rather modest growth and earnings numbers in recent years which is mainly due to adverse events that affected its business. In FY19, when the company’s Southern operations were hit by flood, revenue from operations, declined by 7.4 per cent to ₹9,770 crore. The company slipped from profits of ₹141 crore in FY18 to losses of ₹4.7 crore in FY19. In FY20, the revival was interrupted by the shut-down of operations in March due to Covid. Revenues improved by 3.4 per cent in FY20 to ₹10,100 crore with profits rising to ₹142 crore. In the first nine months of FY21, with lock-downs hampering operations in a big way, revenue dropped by 30 per cent to ₹5,516 crore as against ₹7,960 crore in the corresponding period of FY20. The company incurred a loss of ₹80 crore in this period.

This has led to Kalyan’s per share earnings fluctuating from ₹1.7 in FY18, to negative territory in FY19 to ₹1.7 in FY20. Given that FY21 numbers represent an unusual year, it is best to evaluate the offer valuation on FY20 earnings. At a price band of ₹86-87, Kalyan Jewellers is valued at a price earnings multiple of 58 times (post dilution) and is cheaper compared to Titan (84 times), a diversified company that apart from jewellery, draws revenues from watches and eyewear.

Even though Kalyan is priced at a discount to Titan the margin of Titan’s jewellery segment at 12.3 per cent is higher compared to Kalyan’s 7.5 per cent in FY20.

Given that Kalyan’s numbers have been hit by multiple adverse events, an earnings recovery is quite possible in future as its recent store openings contribute to revenues. On that will ride the future prospects of the stock.

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