Forget Titan and Focus on this Smallcap Jewellery Stock 

Hi guys, this is Aditya Vora. Hope you guys are doing well.

We come from a land where GOLD has always dominated our preference for jewellery buying.

Be it Diwali or Akshay Tritiya or gifting your daughter during her wedding, Gold has dominated preferences of Indians.

After all, Gold symbolizes wealth.

While I believe that Indians love for Gold will be eternal, however the story in the western world especially North America and other European countries is different.

Gold there is only bought by investors while diamonds are bought for consumption.

What Gold is to Indians; Diamonds is for the western world.

The company which I am going to talk about is a supplier of diamond jewellery to leading global retailers, departmental stores, and wholesalers.

Its products include engagement rings, wedding bands, anniversary rings, bridal sets, earrings, and pendants.

It derives all its revenue from export of jewellery, with USA contributing to 95% of sales. The diamond and jewellery business has elements of seasonality with third quarter witnessing positive momentum from Thanksgiving /Christmas and festive season.

The company I am talking about is Goldiam International.

Goldiam International started as an exporter of cut and polished diamonds. However, over the years the company's business model has evolved from a commodity business of diamond manufacturing to forward and backward integrated diamond jewellery production and sales.

Before I give you 5 reasons why this company is expected to do well in the medium to long term with hiccups in the short term, let us talk about few concepts in the diamond industry which are very important to understand the scope of the opportunity.

Lab grown diamonds are manmade carbon while natural diamonds are pure and natural carbon atoms. It takes 6-8 weeks to grow lab grown diamonds using machinery while as you know the natural diamonds are found under the earth's crust.

In terms of appearance, the Lab grown diamonds look the same as natural diamonds. You and me will not be able to make out the difference between the two.

As per research, the size of the natural diamond market is US Dollar 79 bn while lab grown diamonds barely account for US dollar 2-3 bn.

Imagine if you could buy two diamonds for the price of one - The pricing is the USP for lab grown diamonds. With all other characteristics being the same (refer above table), millennials are moving towards Lab grown diamond jewellery. Also, when the cost of a diamond is 40% lesser, the addressable market expands.

LGDs account for only 3% of overall jewellery sales in the US and are expected to account for 10% of the diamond market by 2030.

In my view, the opportunity has just started in terms of size and scope of the market.

So, let's talk about Goldiam Internationals product portfolio.

75% of its sales come from natural diamond jewellery which is basically the bread and butter of the company while Lab grown diamond jewellery accounts for 20% of its sales and the remaining 5% comes from Lab grown diamonds.

If you look at the margin profile, Natural diamond jewellery gives it a 18-20% operating margin while Lab grown diamonds jewellery has a 30% operating margin and the highest margins of 45-50% are when they sell lab grown diamonds.

If you also look at the geographical mix, North America accounts for 95% of its revenues.

So, the question is, why do I like Goldiam International?

Let me give you 3 reasons for that.

The first being, I see a massive growth opportunity in Lab grown diamond jewellery going forward. The market is going to explode. The share of lab grown diamond jewellery has increased from barely 10% a year ago to 20% and is expected to go to at least 30% over the next couple of years.

Also, lab grown diamonds fetch a higher margin of 30% as compared to 18-20% in natural diamonds.

Secondly, what Goldiam has done is that it acquired 88% stake in a company called Eco friendly Diamond which is engaged in growing and manufacturing lab grown diamonds.

This is a master stroke as it gives Goldiam an edge against its competitors who outsource jobs like growing or cutting lab grown diamonds to outside vendors which do not have uniformity and run in to quality issues.

Post this acquisition, not only does it keep a quality check but also gives it a strong operating leverage and higher margins due to backward integration. The entire supply chain in lab grown diamonds is controlled by Goldiam. Currently, Goldiam sources 20-25% of the lab grown diamonds in house via backward integration. To increase the sourcing of lab grown diamonds, its subsidiary eco-friendly diamonds is undertaking a Rs 10 crore capex and in FY24 is likely to double capacity.

And lastly, if you look at the financials, the company's EBITDA margins increased from high single digits during the FY10-16 period to 19% in FY22 and return on equity stands at 21% while average ROCE was at 28-30%. The company remains net debt free company as on September 22 with a strong balance sheet.

Further, the company has been generous in returning cash to shareholders in the form of dividends and buybacks. The management endeavours to maintain a minimum pay-out ratio of 50% of standalone net profit either in the form of dividends or buyback.

Now that you have got a sense of why this company makes the cut for a good investment opportunity, let's talk about the concerns which people may have.

Now with 75% of the product portfolio still coming from natural diamond, a major apprehension a lot of people had was whether Lab grown diamond Jewellery will grow at the expense of natural diamond for Goldiam?

Well, that's not the case.

Lab grown diamond jewellery addresses the white space in the jewellery industry and has only expanded the target audience. Lab grown diamonds are creating a niche of its own. The end customer for Lab grown diamond purchase is someone who never bought natural diamond jewellery in the past as they could not afford it. The Lab grown diamond market is creating a category of its own by converting customers who bought Swarovski diamonds, silver jewellery and smaller different colour stone jewellery. This gives Goldiam an additional revenue stream through the Lab grown diamond market and increased penetration.

One more concern is that if you look at the operating margins, they have gone up from high single digits to roughly 20% currently. The question is are these margins sustainable going forward?

Let's understand why margins improved in the first place.

During the early part of the decade, Goldiam was largely dependent on wholesalers for selling its products. However, over the past few years, it has built strong relationship with global retailers (40-60 stores) and departmental stores. The retail to wholesale mix at present is 80:20. This is one of the reasons for sharp improvement in the operating profit margins.

Apart from the shift from a wholesale to retail focused supplier, the company is also focusing on online sales channel. Goldiam's share of online diamond jewellery sales is at ~20% compared to 5-10% in the industry while the Traditional Brick & Mortar category accounts for the remaining 80% share.

A change in business model along with high margin lab grown diamonds will keep margins steady at these levels.

Lastly, with 95% of sales to North America and all of us know that the US economy is in recession and is expected to be there for some time till the fed stops hiking rates, why am I recommending this stock.

2 reasons.

Firstly, if you look, the main pressure is coming from the natural diamond jewellery market which is 75% but is expected to go down as the share of lab grown jewellery increases. While I agree, for the short term the pressure in demand will continue due to the inflationary pressure and postponing of buying, lab grown diamonds will relatively take a lesser hit.

Secondly, there is a reason why the stock has fallen by 30% over the past 1 year and is trading at a PE ratio of 13 times. To put the numbers in perspective, the company did an EPS of 9.6 rupees in FY22 and during the first half of FY23, despite recession and weak demand the company did an EPS of Rs 3.7. Assuming the same muted trends continue, and it closes FY23 at Rs 8 as the second half of the year will have thanksgiving and Christmas. For FY24, conservatively I am taking an EPS of Rs 8, that means no earning growth due to recession in the US. Still at Rs 8, the stock is trading at a PE multiple of 15 times.

For a company which has entered a high margin new product and supplies to the top retailers like Macys in the US and other marquee names, I believe the valuations are cheap.

It is during bad times in the industry good quality shares are bought.

So that was Goldiam International for you. Thank you and do let me know what you feel about the company.