PC Jeweller Research Report By Motilal Oswal

Demand outlook robust; growth opportunity massive

Domestic jewelry retail business to grow at a CAGR of 25-30% over the next five years

We recently met the management of PC Jeweller (PCJL). Our key takeaways:

 PCJL remains confident of 25-30% CAGR in the domestic jewelry retail business over the next five years.

 The franchisee model is working well so far; going forward, franchisee stores will be ~80% of incremental annual store openings.

 PCJL has massive opportunity to grow at the cost of unorganized players. Though competition from organized players will increase as the salience of the organized segment goes up 3-4 years down the line, the company believes its strengths on design (craft) and low cost manufacturing will serve it well in the long term.

 We have a BUY rating on the stock, with a target price of INR645, valuing the company at 29x December 2018E EPS, 40% discount to Titan. We believe that the valuation gap vis-à-vis Titan will shrink further, once PCJL demonstrates its ability to maintain its revenue and earnings trajectory.

Domestic business can easily grow 25-30% over next five years

Growth momentum continues to be strong in the domestic business, as organized players are gaining share sharply. Earlier, unorganized players were able to evade both direct and indirect taxes and had practices like under-caratage, which is no longer possible. The management expects 25-30% CAGR in domestic business over the next five years, led by 10-15% SSSG and 15% growth through new store additions. Proportion of cash sales has declined from 60% earlier to 35-40%. Another 40% of sales now come from credit cards and 20-25% from gold exchange, indicating changing customer practices. Near-term growth in the exports business is likely to be subdued due to introduction of 5% VAT from January 01, 2018 in UAE (one of the major buyers of Indian jewelry) on the back of 5% customs duty imposed in January 2017. Jewelers are still awaiting clarity on whether VAT will be applicable on re-exported gold jewelry. We believe that sharp growth in the domestic business along with 5-8% growth in the exports business over next five years will lead to the share exports declining down below 20% of the standalone business (34% in FY17 and 32% in 1HFY18).

Franchisee model doing well; will help improve RoCE substantially

The franchisee model is working well so far for PCJL. It is confident of opening its 100th overall store by the end of the current fiscal. It has already done market studies and is ready with the expansion plans for the next two years. Going forward, franchisee stores will be ~80% of annual store openings. Robust systems for control are also in place to support the backend. Franchisees are able to turn over gold jewelry 4x a year and diamond jewelry 2x a year. With RoCEs of 20%, the business is attractive to potential franchisees, who also get gold on lease from banks. Use of technology helps to further lower working capital requirements for PCJL.

Starting with high-end jewelry initially, virtual reality goggles at stores will enable viewing of merchandise from other stores in the city, other stores in the state and stores in different parts of the country as well, which will then be shipped to the customer. PCJL plans to add virtual stores in airports and malls as well. With the ability to get guidance from experts on suitability, the company will have facilities enabling ordering from these stores as well in two months’ time. Expansion through franchisees and high asset turns will help improve PCJL’s RoCEs substantially over the next 3-5 years.

Design and manufacturing capabilities to be the key differentiator

PCJL believes that competition from organized players is not an issue today, but will increase, as the salience of the organized segment goes up (currently 30% of jewelry in India) 3-5 years down the line. Yet, it believes that its design skills and lower cost of manufacturing will act as key differentiators. The company has introduced a range of wedding jewelry (including premium jewelry under the Azva brand) as well as light-weight jewelry to stay ahead of the competition (unorganized and regional organized players). It has also increased its annual ad spends to support the new collection and brand image. Its ad campaign introducing new brand ambassadors, Akshay Kumar and Twinkle Khanna, has received good response. PCJL will have four campaigns a year – two for gold jewelry and two for diamond jewelry, enabling increasing proportion of studded sales. It also aims at own manufacturing (75% of sales) of 100% in 3-4 years, which will help reduce cost of manufacturing and will also give higher control on execution. PCJL currently has four factories in the NCR.

Valuation and view

Organized players have only ~30% share of the INR2t jewelry market in India, with the national players having <10% share. However, armed as they are with the advantages of scale, technology, brand trust, superior hedging policies, wider variety and huge marketing muscle, nation-wide players like PCJL will continue to take share away from the unorganized players for whom the pressures of compliance have whittled away at their ability to offer lower rates to consumers. The value migration to organized players is so strong that Titan and PCJL are expected to report by far the highest EPS CAGR over FY17-20 in our Consumer and Retail universe. While PCJL might not have had the first mover advantage that Tanishq had, it has emerged as India’s second-largest Jewelry Retailer in little over a decade. We value the company at 29x December 2019E EPS (implying 40% discount to our target multiple of 49x for Titan) and get a revised one-year target price of INR645 for PCJL – an upside of 17%