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Titan: Building blocks - Views on News from Equitymaster

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Titan: Building blocks
Jul 26, 2006

Performance summary
It has been a good start for Titan for the fiscal year 2006. On the back of aggressive promotions, the jewellery division of the company has reported impressive numbers. Though there has been a sharp drop in the PBIT margins of the jewellery division, it is largely due to aggressive campaigns. Excluding the deferred related adjustments and extraordinary items, net profit has registered a 39% YoY growth during the quarter.

(Rs m) 1QFY06 1QFY07 Change
Net sales 2,930 4,410 50.5%
Expenditure 2,751 4,220 53.4%
Operating profit (EBDITA) 178 190 6.8%
EBDITA margin (%) 6.1% 4.3%  
Other income 5 14 187.8%
Interest 58 49 -15.7%
Depreciation & amortisation 49 49 1.0%
Profit before tax 77 107 39.0%
Extraordinary expenses (50) (54) 7.4%
Tax (24) 12  
Profit after tax 50 41 -18.5%
Net profit margin (%) 1.7% 0.9%  
No. of shares (m)* 42.3 44.4  
Diluted earnings per share (Rs)**   16.6  
P/E (x)   34.6  
(*post rights issue capital base, **trailing twelve month earnings)

What is the company's business?
Titan is the market leader in the organised watch (46% of FY06 sales) and jewellery (54% of FY06 sales) segments. Watches account for 73% of overall PBIT with the rest being accounted for 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 there and is now focusing on building the export business in a gradual manner (particularly in the Middle East).

What has driven performance in 1QFY07?
New launches and new launches: As is evident from the table below, all the key divisions of the company registered impressive growth numbers. This is despite the fact that the first quarter of a fiscal year is a lean season, in terms of demand for jewellery and watches (demand tends to be higher in the second half of the fiscal year owing to festivals). The 'Fast Track' brand of products continues to gain significant traction from innovation. As far as the jewellery division is concerned, the expansion of retail presence is gaining steam (from around 84 showrooms, 'Tanishq' is expected to touch the 100 mark by 2008) accompanied by new promotional schemes has driven topline growth. The management expects this division to clock revenues of Rs 10 bn in FY07 (Rs 7.9 bn in FY06) and given the 1QFY07 performance, it seems that it is well on its way to achieve the same. Over the next three years, the 'others' division will gain significance, not because of higher revenues from accessory sales, but from the precision engineering initiative.

Segmental break-up…
(Rs m) 1QFY06 1QFY07 Change
Revenues - Time products 1,261 1,487 17.9%
PBIT margin 5.4% 8.7%  
Revenues - Jewellery 1,661 2,883 73.5%
PBIT margin 5.6% 1.9%  
Other businesses* 84 136 61.6%
PBIT margin -33.4% -22.6%  
Overall EBIT margin 4.4% 3.4%  
(*includes precision engineering, licensed products and accessories)

Margin - No issues: In our view, the margin decline is not something to be alarmed of. Except for the stock adjustments and increased advertising expenses (8.8% of sales in 1QFY06 to 9.1% in 1QFY07), all other major overheads have declined as a percentage of sales during the quarter. Even in the case of advertisement expenses, given the heightened competition, it is pertinent that Titan increases its ad-spend to sustain growth. As far as segmental performance is concerned, there has been a sharp decline in jewellery division margins in 1QFY07. But this is largely due to promotional campaigns (special discounts), which will even out as rest of the fiscal unfolds. That said, the scope for improvement in margins from here on will be difficult and much of it has to come from the 'others' segment over the next two to three years.

Deferred tax effect: Last year, Titan had reported a deferred tax credit of Rs 36 m. In 1QFY07, the deferred tax credit was only Rs 6.7 m, which is the key reason for the decline in net profits. Extraordinary items in 1QFY07 include Rs 25 m towards VRS expenses and Rs 29 m towards provision for doubtful debts. Excluding these two adjustments, net profit in 1QFY07 is actually higher by 39% YoY. Post the rights issue, the company has parked the surplus funds, which has boosted other income during the quarter. We expect a significant reduction in interest cost in FY07, as the company will utilise issue proceeds to retire high cost debt (already the balance preference shares to the tune of Rs 400 m was retired in 1QFY07). Overall, an encouraging show by Titan, which we expect to sustain over the next three years.

What to expect?
At Rs 574, the stock trades at a price to earnings multiple of 14.4 times our estimated FY08 earnings. We had recommended a 'Sell' on the stock at Rs 791 early this year. Since the stock has declined by more than 27% since our recommendation, we now have a 'Hold' view on the stock from a three-year perspective.

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