• MARCH 29, 2012

Classic Diamonds: Glitter is only skin deep

It appears to give the impression of being run in a very unprofessional manner

The sparkle isn't there

Given the glamour quotient associated with this industry, one would think that the manufacturing and retailing of gems and jewellery is the ultimate business to enter into. The industry has a ready market and a sassy clientele to hawk its wares to. (Besides, diamonds are a girl's best friend or some such). However a look at the annual report and accounts for the 12 months ended March 2011 of Classic Diamonds would shatter any such illusions. Forget the financials, they are tepid-- it is also about the most shoddily produced annual report that I have ever purveyed. For example, the words lakhs is spelt as lacks. Even some of the accounting entries are a knockout of sorts.

Controlled by the Bhansali family, it is a lilliput among the listed companies in this sector monitored by Capital Market magazine. The magazine lists the financials of 16 diamond jewellery companies. Classic Diamonds comes in at No 13 in terms of revenues - Rs 5 bn. The big daddy in this list is Rajesh Exports with gargantuan revenues of Rs 200 bn, followed by Shree Ganesh Jewels with revenues of Rs 52.4 bn. And surprisingly enough, in terms of operating profit margins, the company tunes in at No 6. But in terms of return on net worth it weighs in at No 13 again.

The management consumed by tectonic shifts

During the year the board of directors went through some tectonic shifts. Four of the eight directors resigned including the patriarch Mr Chandrakant Bhansali. (The resignation of Chandrakant has not been highlighted in the annual report. Probably he resigned due to old age or something). His son Kumar C. Bhansali is the chairman and managing director, while Kumar's son Nirav is a whole-time director. The directors who resigned were replaced by two new directors who were appointed to the board. Why there was such a mass shuffle in the board has not been explained one bit. But regardless of the change in the constitution of the board, the promoters hold an unassailable 64.8% of the total voting stock of Rs 78.4 m in the company. Besides the directors, a new auditor also came on board. The old auditor resigning on the ground that it is not a peer reviewed firm, which audit firms have to compulsorily be to audit listed companies. Is this some new requirement or what?

The way the company cranks out its revenues, it buys roughs and after polishing them and adding other value, retails the diamonds. It also sells diamond jewellery. Then it also buys traded goods for resale. It is not known whether it adds any value to such traded goods before resale. It is of course very difficult to make much sense of the myriad figures that dot the financial statements. But from ones understanding of the company's working. It has five plant locations presently in Mumbai which comprises the diamond division and the diamond/ jewellery division. It also intends to set up a factory near Surat which will be able to produce diamonds and jewellery for the newer markets.

Its revenue accretals

The company also has its own definition of its revenue for the year. The gross sales turnover is shown as Rs 5 bn, with other income of Rs 1.7 m. But given the sharp fall in the inventory value at year end over that of the preceding year, it has reduced this negative difference from sales. This difference amounts to a very sizeable Rs 1.6 bn and the company has thus arrived at net revenues of Rs 3.4 bn. Strictly speaking, in accounting parlance, any such difference in stock values over two years is adjusted against material consumption. (Done in this manner the sales figure does not get dislodged). In this particular instance the value of material consumption is shown as Rs 1.6 bn. If one were to include the fall in the inventory value, then the material consumption value will double to Rs 3.2 bn. (The sales and material consumption figures in turn are used to calculate the material consumption to sales ratio). This then is the power of accounting - the ability to inflate or deflate revenues and expenses at will just by the flick of a pen. In this particular instance it gets a bit grotesque as the material input costs also involves the purchase of traded goods worth Rs 1.2 bn against Rs 3.7 bn purchased previously. (It may be noted that the company drastically reduced the value of imported traded goods to 14% of all traded goods from 31% previously). Thus the total cost of material consumption (assuming that all the traded goods have been hawked) goes up to Rs 4.36 bn. Juxtaposed against revenues of Rs 5 bn; it reveals a slim value addition to the cost of inputs.

Alls not well

As a matter of fact all is not well with this company. It is haemorrhaging internally. The company registered both lower sales and profits. Sales were down 23%, and the pre-tax profits slipped 57% to Rs 75 m. And also abetting the lower pre-tax profits is the heavy interest outflow quotient. The interest payout rose marginally to Rs 310 m from Rs 305 m previously in a year when the borrowings at year end fell marginally to Rs 3 bn from Rs 3.2 bn previously. This would imply on a rough basis an interest payout of around 11% during the year. But as stated earlier the company is having problems of a different kind and the situation appears self imposed. On sales of Rs 5 bn, the debtor value at year end is Rs 4.3 bn, and 75% of these dues are over 6 months old. In other words the company is forced to offer or is conspiring to offer almost 12 months credit on sales to generate the cash flow. Fortunately, the provision for bad and doubtful debts on sales is only a whisker of the trade debts on hand-for now. To add to its miseries the sundry creditors at year end fell sharply to Rs 590 m from Rs 1.36 bn previously. It is a small wonder then that the company has to borrow big just to stay afloat. Even the directors seem to show some concern about its welfare. The company owes moneys to the tune of Rs 30 m to its directors. What type of business is this anyways?

The company has the following to offer by way of explanation. The year could not see a revival of business from the US sector as there were differences in opinion with its major customer. However your company now intends to penetrate this market all by itself, starting from scratch which would take a couple of years to gear up. Just like that! If it did have differences of opinion in the first place why then did it continue to have such extensive deals with this customer? What are the sums involved? And who pray is this customer who is not paying up, and how does it intend to recover its trade receivables? It goes to add an even more intriguing tale. It says 'the company has been struggling in materialising its debtors at a fast pace due to the conflicts between the distribution arms worldwide'. Therefore, it would appear that the inability to recover its dues is a conflict within the family, rather than without. Therefore the question that comes to mind is, is this a collusive conflict or a genuine conflict? Is there any connection between the resignation of half the board of directors on the one hand, and the situation enveloping the company on the other?

The figures do not add up

Somehow the figures and the words do not quite pan out. Why do I say this? The company in another schedule says that sales to its associates, apparently Aarohi Ltd and Aarohi LLC, amounted to only Rs 1.5 bn against Rs 2.4 bn previously. (The company boasts of 13 associate companies - all of whom appear to be in the allied business). That would amount to only 30% of gross sales, against a marginally higher 34% previously. Debtor dues from associates at year end on the other hand amounted to only Rs 794 m against Rs 1.1 bn previously. In percentage terms that amounts to 19% of all debtor dues against 27% previously. Separately another schedule shows group company debtor balance of Rs 724 m as against Rs 974 m previously. It is not known how the company can have two group company debtor figures in the same year simultaneously. The total purchases from affiliates in 2010-11 on the other hand are only a piffling of the gross purchases, against such purchases of Rs 1.2 bn previously. There is a dichotomy here between what the figures reveal and what the directors' report has to say in the matter. Obviously then the problem of non recovery of dues is not with sales affected to affiliates but to third parties. This is contrary to what the directors' report has to say about conflicts between the distribution arms worldwide.

The way the operations pan out, a little over 91% of the raw materials consumed is imported as is the vast bulk of the exports. The FOB Value of exports was Rs 4.7 bn against Rs 6.7 bn previously. This dependence on imports/ exports to generate its revenues has its own negative side effects. It manages the remarkable feat of losing money on the exchange rate difference on sales. In 2009-10 it lost Rs 211 m in this manner, but in 2010-11 the loss was pared down to Rs 64 m - moneys that it can scarcely afford to lose. In any event how did it manage to lose money both ways in both the years? Separately, the cash flow statement has a different take altogether on the amounts involved on the exchange fluctuation account. These figures in turn differ from the gains that it recorded on its forward contract options in either year. The many bewildering and complex entries that go to make up its accounts!

The P&L account

In any event sales fell sharply by 23% to Rs 5 bn from Rs 6.5 bn. It was unable to extract any reduction in the cost of material inputs, and thus the material input costs as a percentage of sales were almost identical at 88.1% against 88.9% previously. This is the only significant item of revenue expenditure. The generation of other income took a dive to a mere Rs 17 m against Rs 117 m previously. But the bulk of the other income in either year is of the indeterminate variety. What helped contain the fall in profits to an extent was the reduction in HR costs by 45% to Rs 102 m. But these are trifling expenses on revenue account. The plain fact is that with the fall in sales, and with razor thin margins to boot, the pre-tax profit plummeted to Rs 75 m from Rs 177 m previously. Being a good corporate citizen it even made a tax provision on its pre-tax profit in either year. But at the end of the day, the miniscule post tax profits and the precarious financial situation precluded any dividend payment.

The company's muddled functioning leaves for a sour taste in the mouth. The company makes some positive noises about its future outlook, but that is only to be expected. Presumably it can't be any worse than it is in now. Besides, the diamond jewellery business on the face of it appears to generate a very low value addition. There are much better avenues for investment for the discerning investor.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme.

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.