PC Jeweller Ltd One-time assessment CRISIL IPO Grade 3/5 (Average) November 6, 2012 Grading summary CRISIL has assigned a CRISIL IPO grade of ‘3/5’ (pronounced "three on five") to the proposed IPO of PC Jeweller Ltd (PCJ). This grade indicates that the fundamentals of the IPO are average relative to the other listed equity securities in India. However, this grade is not an opinion on whether the issue price is appropriate in relation to the issue fundamentals. The grade is not a recommendation to buy, sell or hold the graded instrument, its future market price or suitability for a particular investor. PCJ is an established jewellery retailer in North India. The assigned grade reflects its seven-year-old presence and the ensuing strong reputation in an industry quintessentially benefited by the country’s obsession for gold. Strong brand recall, successful branch expansion (from one to 30 showrooms in the past seven years) and stellar increase in gold prices have added shine to PCJ’s top line, which has grown at a three-year CAGR of 69%. The grade factors in the resilience of demand for gold jewellery in India despite high gold prices; we expect demand to revive in the long term as gold prices stabilise. Compared with other gold jewellery players, PCJ’s revenue mix leans towards higher-margin diamond jewellery, which is rewarding in the wake of increasing acceptance of diamond jewellery in India. The grade has also taken into account the expected increase in organised retail penetration in jewellery vis-à-vis the single-store format, which will benefit established players such as PCJ. However, competition in the jewellery retailing market - likely to intensify following planned expansions by regional/traditional players - poses a significant risk. Further, PCJ’s stores are concentrated in North India (four showrooms in New Delhi accounted for 44% of FY12 revenue from operations). PCJ’s plans to add 20 showrooms by FY14 across India should mitigate the risk of regional concentration but the opening of new showrooms in a competitive market is likely to put pressure on profitability due to higher marketing expenses and working capital requirement. Also the compensation structure for key management personnel appears low which can result in attrition. PCJ’s revenue from operation increased at a three-year CAGR of 69% between FY09 and FY12 to Rs 30.4 bn, largely driven by branch additions and steady increase in gold prices. EBITDA margin remained steady at 9-10% over FY09- FY12 due to hedging of gold and stable overhead costs. PAT increased sevenfold over the past three years to Rs 2,313 mn in FY12. The company registered robust RoE of 55% over FY09-FY12. 1 CRISIL IPOGradingRationale About the company The company was established in 2005 after a split between the two partners. PCJ (Delhi-based) is promoted by brothers Mr Padam Chand Gupta and Mr Balram Garg. The company retails gold jewellery (66% of FY12 revenue from operations) and diamond-studded jewellery (32%) under the “PC Jeweller” brand. It has 30 showrooms across 23 cities in North and Central India totaling ~164,572 sq ft as on September 30, 2012. The domestic market accounted for 67% of FY12 revenue from operations and exports the rest. The company’s manufacturing units for gold and diamond-studded jewellery are located in North India. It intends to add 20 new showrooms by FY14 using the proceeds from the planned IPO. History and key milestones Year Key milestones 2005 Incorporation Opened showroom in Karol Bagh, Delhi 2007 Opened two showrooms in Noida and Panchkula Commenced exports from manufacturing unit at the Noida SEZ 2008 Opened two showrooms in Faridabad and Dehradun 2009 Commencement of operations at the manufacturing unit in Selaqui, Dehradun Opened two showrooms in Pitampura and Chandigarh 2010 Commencement of operations at the second manufacturing unit in Selaqui, Dehradun Opened nine showrooms in Preet Vihar (Delhi), Ghaziabad, Gurgaon, Lucknow, Indore, Bhopal, Raipur, Jodhpur and Bhilwara 2011 Conversion from a private limited company to a public limited company Commencement of operations from the second export unit in the Noida SEZ Opened eight showrooms in Ludhiana, Haridwar, Bilaspur, Pali, South Extension, Beawar, Ajmer and Amritsar 2012 Opened six showrooms in the first nine months of 2012 Source: DRHP, Company Issue details Shares offered to public 45,133,500 As per cent of post issue equity 25.2% Object of the issue • Finance the establishment of new showrooms • General corporate purposes Amount proposed to be raised Not available at the time of grading Price band Not available at the time of grading Lead managers SBI Capital Markets Ltd, Kotak Mahindra Capital Company Ltd, IDBI Capital Market Services Ltd Source: DRHP Use of IPO proceeds Sr .No Expenditure item Estimated cost (Rs mn) 1a. Capex for the establishment of new showrooms 599 1b. Estimated cost of finished products 5,100 1c. General corporate purposes and issue expenses N.A Total 5,699 Note: Rs 599 mn towards capital expenditure of 20 showrooms with total area of 133,000 sq ft translating into capex of Rs 4,500 per sq ft Source: DRHP 2 YEARS MAKING M AR K E T S F U N C T I O N B E T T E R Shareholding pre- and post-issue Pre-issue Post-issue Category of equity shareholders No. of equity shares % No. of equity shares % Promoter & promoter group 125,404,500 93.6 125,404,500 70.0 Padam Chand Gupta 50,371,800 37.6 50,371,800 28.1 Balram Garg 66,002,700 49.3 66,002,700 36.9 Promoter group 9,030,000 6.7 9,030,000 5.0 Others 8,562,000 6.4 8,562,000 4.8 Public 45,133,500 25.2 Total 133,966,500 100 179,100,000 100 Source: DRHP 3 CRISIL IPOGradingRationale Detailed Grading Rationale A. Business Prospects Gold demand weakens in H12012 but long-term story intact Demand for gold jewellery (65% of India’s overall gold demand) has historically been resilient despite a significant increase in gold prices. In 2010 and 2011, when gold prices consistently scaled new heights, demand for gold (jewellery+ investment) in India continued to be high at 1,006 tonnes and 961 tonnes, respectively. India’s demand for gold touched an all-time high in 2010 but declined by just 4% in 2011 due to a 31% rise in the rupee price of gold. In H12012, local demand for gold has weakened with a 20% rise in prices. Further, higher gold imports prompted the government to hike the import duty on gold to 4% of the value in March 2012 to cap the widening current account deficit. Hike in import duty, rise in international gold prices and a weak rupee resulted in 33% y-o-y decline in gold imports to 389 tonnes during H12012, according to the World Gold Council (WGC) report; however, in value term, it declined by only 10%. Although short-term demand is expected to be subdued on account of a sharp rise in gold prices, demand should revive in the medium to long term as gold prices stabilise. Jewellery dominates gold demand Demand for gold weakened in H12012 (tn) ($/oz) 1,200 30,000 1,000 25,000 800 20,000 Gold demand in India (Tonnes) 2009 2010 2011 H1-2012 600 15,000 Jewellery 442 657 595 277 400 10,000 Retail investment 136 349 366 112 200 5,000 Total 579 1006 961 389 710 769 713 579 1006 961 389 0 0 2006 2007 2008 2009 2010 2011 H1-2012 Indian gold demand Gold Price (RHS) Source: WGC Source: WGC, CRISIL Research Gold is still considered a good investment In India, gold is perceived as: ■ An easily encashable asset or investment ■ A financial security and an indicator of social status ■ An asset passed on from one generation to another These fundamental factors have kept Indians’ demand for gold relatively resilient over the past few years despite a steady rise in prices. 4 YEARS MAKING M AR K E T S F U N C T I O N B E T T E R Branded jewellery – greater acceptance… Jewellery sales remain the stronghold of traditional jewellers and local outlets. However, the share of organised players (defined as retailers with more than one store in similar formats) is expected to increase from the current 8-10%. Multi- store players including regional/traditional players such as PCJ, Thangamayil Jewellery, Tribhovandas Bhimji Zaveri, Joyalukkas, GRT Jewellers, Swarovski, etc. as well as pan India jewellery players such as Tanishq and the diamond- focused Gitanjali, who sell jewellery under various brand names, are set to gain. Extensive marketing promotion by major players, rising awareness about hallmarked jewellery, contemporary designs and aspirational value of brands are collectively prompting a preference for organised jewellers from traditional family jewellers. … to benefit established players with rising organised retail penetration Traditionally, the jewellery retailing space in India has been dominated by the family jeweller largely due to factors such as considering certain jewellers as trustworthy and auspicious. As a result, organised retail penetration (ORP) in domestic jewellery retailing is estimated to be a mere 8-10%. However, this is expected to increase on the back of: ■ Higher disposable income ■ Increasing customer awareness about hallmarking (quality assurance). The recent approval on mandatory hallmarking will also accelerate the pace ■ Assured buy-back scheme by organised players (since jewellery is seen as an investment) ■ Aggressive branding by organised players ■ Retail distribution allowing customers across locations to enjoy similar experiences leading to greater convenience Established players such as PCJ are well placed to benefit from this shift in consumer preference.