Already a 10-bagger in two years, can this jewellery maker topple Titan?

I think it’s hard.

Jewellery companies are not exactly known for their wealth creation abilities. But why is this? Why are jewellery companies unable to create a lot of value for their owners or shareholders?

It has to do with the structure of the industry.

We have done some analysis and found that on average, raw material expenses account for 94% of gross sales for jewellery companies. If you have only ₹6 left over on sales of ₹100 after paying for raw materials, you’re skating on very thin ice.

And the less said about the net profit margin the better. The average net profit margin of listed jewellery stocks in India stood at a mere 1.5% between FY14 and FY23.

The diamond and jewellery industry has earned on average a measly ₹1.5 on sales of every ₹100 in aggregate over the past 10 years. Honestly, I don't know of any other industry where profit margins are this low.

To make matters worse, starting a jewellery business needs a huge upfront investment. The business is also quite cyclical. Demand soars during the wedding and festive seasons and slows down dramatically for the rest of the year.

Capital requirements are also huge. The business requires you to maintain a large inventory, which locks up a big portion of your capital.

This combination of large capital investment and low profit margins has been the undoing of most Indian jewellery companies.

The average return on equity earned by listed jewellery companies between FY14 and FY23 stood at 13%. This is indeed below par. You are not considered a decent business if your average return on equity is less than 15%.

The outlier

However, there is one jewellery company that's not just a decent business but a great one. It has been one of the biggest wealth creators in the last couple of decades.

I am talking about none other than the big daddy of the jewellery market – Titan Company Ltd.

What makes Titan special? Well, it accounts for just 10% of the aggregate revenue of listed jewellery stocks in India, but brought in almost 60% of the entire sector’s profits in FY23.

Titan's 25% return on equity is also significantly better than that of the overall industry. It has done this consistently over a decade. That’s because Titan has managed to do something its peers have struggled with. It has been able to charge a hefty premium at its Tanishq outlets. Customers have been more than willing to pay this premium in exchange for the trust and the credibility it commands. 

I asked one of my jeweler friends why Titan's jewellery was more expensive than the competition’s. His one-word answer was “brand".

You see, jewellery is a tricky business. You could end up with a substandard product if you don't buy from a trusted jeweller. Titan’s strength is that it has managed to position itself as one of the most trusted brands. This, along with its presence across India, its unique designs and its economies of scale have allowed Titan to earn margins that are almost twice the industry average.

So the verdict is clear. To be a wealth creator like Titan, you need to be able to charge a hefty premium from customers in exchange for trust and reliability.

The challenger

Is Kalyan Jewellers up to the task? A look at the company's operating margins and net profit margin offers no indication that it has Titan’s pricing power. Operating margins have averaged 7% over five years, versus 11% for Titan. Net profit margins have averaged just 1.3% versus almost 7% for Titan. Its return on equity has averaged close to 10%, which is not only significantly below Titan’s but also below that of a decent business.

However, Kalyan Jewellers is trading at almost 100 times its latest 12-month earnings. That means the stock is even pricier than Titan’s, which is trading at 90 times earnings.

It appears that investors expect Kalyan Jewellers to have the same success as Titan or perhaps even better. However, there are no signs of that right now. Kalyan Jewellers remains an average business at best and will need a miracle to be in the same league as Titan.

Do you agree? Or do you believe that Kalyan Jewellers’s future will be much better than its past?

The company is expanding aggressively, largely through the franchise model. It is also pursuing aggressive measures to reduce debt. But it all boils down to how much of this expected growth is already baked into the stock price.

As we saw, the stock price assumes a very rosy future for Kalyan Jewellers. Should the company fail to live up to expectations, the stock could take a severe beating, so it’s best to be wary.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. 

This article is syndicated from Equitymaster.com