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Titan: Running ahead of fundamentals? - Views on News from Equitymaster
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Titan: Running ahead of fundamentals?
Jul 20, 2005

Performance summary
Titan has announced its results for the first quarter ended June 2005. It has been a allround show in 1QFY06. While the topline growth at 43% is commendable, what is also noticeable is the improvement in operating margins. Both the divisions are now profitable (based on the margin trend in the first quarter in the last three years). As compared to a net loss in 1QFY05, the company has posted a net profit in this quarter.

(Rs m) 1QFY05 1QFY06 Change
Net sales 2,003 2,862 42.9%
Expenditure 1,925 2,684 39.4%
Operating profit (EBDITA) 78 178 129.5%
EBDITA margin (%) 3.9% 6.2%  
Other income 5 5 -7.5%
Interest 77 58 -24.9%
Depreciation 48 49 1.0%
Profit before tax (42) 77 -
Extraordinary income/(expense) (37) (50) 35.2%
Tax (22) (24) 10.2%
Profit after tax/(loss) (58) 50 -
Net profit margin (%) -2.9% 1.8%  
No. of shares (m) 42.3 42.3  
Diluted earnings per share (Rs)   4.7  

What is the company's business?
Titan is the market leader in the organised watch (53% of FY05 sales) and jewellery (47% of FY05 sales) segments. Watches account for 76% of overall PBIT with the rest being accounted by the jewellery division. The company also has presence in the precision engineering segment where it plans to leverage on its engineering expertise (revenues are a part of the watches division). After expanding rapidly in the international markets, Titan has scaled down its presence and is focusing on building the export business in a gradual manner.

What has driven performance in 1QFY06?
Time products division leapfrogs:  The average rate of growth in topline of the time products division (including watches, sale of accessories and precision engineering) has been 8% in the last seven years. The 41% rise in revenues in 1QFY06 is definetely of surprise to us. While we believe the watches divsion to have grown by around 10% to 12%, the precision engineering seem to have grown at a much faster pace. We will update our subscribers with respect to the progress on this revenue stream soon. Apart from this, the performance of the jewellery division continues to remain robust. Titan is well on its path to capture the targeted 10% of the organised market by FY08 (estimated to be 7% to 8% by FY06).

Segmental break-upů
(Rs m) 1QFY05 1QFY06 Change
Revenues - Time products 955 1,345 40.8%
PBIT margin -0.4% 3.0%  
Revenues - jewellery 1,141 1,661 45.6%
PBIT margin 1.9% 5.6%  
Overall EBIT margin 0.9% 4.4%  

Profitability also improves:  Though first quarter is typically the lean season for watches and jewellery demand, the sharp improvement in PBIT margins is a big positive. Post this, we will have to upgrade our FY06 estimated PBIT margins for Titan. Without going into expenditure-wise breakup, we believe that the growing contribution from the precision engineering initiative and better scale of operations in the jewellery side will result in further margin improvement. In this context, we are fairly positive on the margin side.

Low interest cost cushion:  By controlling working capital requirement (without taking additional debt or capital), Titan has reduced its interest cost in the last three years. The trend continues in 1QFY06 and in fact, increased profitabilty has accelerated the debt retirement process. The company has announced that the Board of Directors is working on raising capital to fund Titan's long-term expansion plans, which will further strengthen the balance sheet. However, the modalities are yet to be decided. Extraordinary item here, includes provision for dimunition in value of investment in some of its overseas operations and VRS payments.

Over the last few quarters:  As can be seen from the graphs above, while the business is seasonal in nature (to that extent margins are volatile), the first quarter PBIT margin trend clearly reflects the underlying improvement in profitabilty. From losses in 1QFY03, both the division are profitable in 1QFY06 and we expect the trend to continue, though at a slower rate.

What to expect?
At Rs 508, the stock is trading at a price to earnings multiple of 15 times our estimated FY07 earnings, which we believe need to be revised upwards. We believe that valuations adequately reflect the next two year growth prospects of the company and to that extent, investors have to be cautious. The risk-reward equation is highly skewed towards risks, like we had mentioned during our FY05 result analysis.

We had recommended the stock in January 2005 at Rs 173 with a target price of Rs 250 with a two year perspective. Though we expect the company to post robust growth in net profit over the next three years, the fact is that the valuations are at the higher end of the spectrum.

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