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Are the glittering times back for PC Jewellers? - Views on News from Equitymaster
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Are the glittering times back for PC Jewellers?
Jul 26, 2013

The stock of PC Jewellers was hammered after the RBI took some measures to restrict import of gold, in a bid to stem the devaluation of the rupee. Our primary reason for recommending the stock in May 2013 was immunity from gold price volatility due to adoption of gold on lease model, low leverage, attractive valuations and strong expansion plans. However, in a completely unexpected move in June 2013, the RBI rolled out a guideline that any import of gold should be made with only 100% cash margin.

The crisis

For PC Jewellers, that operated on gold on lease model, the 100% cash margin was to entail higher interest cost and lower operating cash flows. We had updated the investors about the possible . implications of changes in regulation by RBI regarding gold imports. While there was not enough clarity from the management on the extent of rise in interest costs, we conservatively factored the changes in our estimates for PC Jewellers. We arrived at a target price of Rs 128 per share and recommended investors to Hold on to the stock.

Change in RBI's stance - a positive

The RBI again released a circular on July 22, 2013 introducing new policy and proposing few changes in the earlier notifications. We shall discuss two specific guidelines which can impact Jewellery companies.

Firstly, and most importantly, the earlier restrictions with respect to import of gold on consignment basis, LC restrictions etc. stand withdrawn. This implies that 100 per cent cash margin requirement while procurement of gold is no longer applicable. Therefore now since the lease model is back, as of now there are no worries with respect to substantial rise in interest cost and its impact on return ratios for the jewellery makers.

Secondly, all nominated banks/nominated agencies should ensure that at least 20% of every lot of gold that they import has to be made available for the purpose of export. Also, any fresh lot of import will be allowed only when three forth of the previous 20% of gold reserved for exports has actually been sold to gold exporters. In simple words, if a bank is importing 100 kg at one point of time; it has to ensure 20 kg of it is sold to exporters. Till then, the gold will lie in custom bonded warehouse. Also, until 15 kg of that gold is exported it cannot place an order for a new lot.

This measure will necessitate banks/agencies to look out for buyers which also export gold. In case of companies which have only domestic operations they may not meet the 20% export requirement of banks. In such case, banks may charge a premium from buyers for selling its gold. One drawback of this new measure is that it can lead to unpredictability of gold prices and volumes.

How will this impact PC Jewellers?

The company held a conference call to discuss the implications of this circular. The management stated that exports already contribute 20-25% of their sales. This means they are in a position to meet the banks requirement of 20:80 principle (export : domestic use) while sourcing gold from them. The management was fairly confident that the new policy will not impact the company much and it will be business as usual for them.

The only concern highlighted by management was that the new policy will make other jewellers enter the export field. This may lead to increase in competition. However, PC Jewellers' has well established operations in the export market. This shall give them an edge over new entrants.

What should investors do?

As the restriction on 'gold on lease' has been lifted; the earlier concern with respect to change in business model of the company is alleviated. Also, the new import policy is not likely to change much for PC Jewellers. However, there may be unpredictability with regards to gold prices and volumes. This is because the banks may charge a higher premium from domestic buyers as the demand for the domestic consumption is much higher than the demand for exports. However, considering the frequent change of stance by RBI on gold import policy, we cannot rule out the possibility that few more changes/reversals may be in the offing until the problem of current account deficit is tackled. Therefore, keeping in mind the regulatory uncertainty, we maintain our Hold view on the stock. We may revisit our estimates once more clarity emerges from the regulatory perspective.

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