Titan Company - Implications of shift to fixed making charges - ICICI Securities

Introduction of fixed price making charge structure (please see our report on this published in 2019 - link), rather than the percentage of gold price model, although a small proportion currently, is something that we will watch carefully. A potential shift to fixed price making charge to a large portfolio could significantly limit Tanishq's price increase lever in the medium-term (note that real revenue for Tanishq is making charges + the premium on gold price (gold commodity price is a pass-through)). We note that Tanishq had shifted to a percentage of gold price making charge structure in FY09, resulting in a step-jump in profitability (see charts 1-2). 'Making charges as a percentage of gold price' has its benefits - every 1% gold inflation (theoretically) leads to 2% Jewellery EBITDA growth. Although there are near-term pressures, long-term formalisation and market share gains narrative remains. For us, Titan stock is about "when to buy" and not "why to buy". Retain HOLD.

Management commentary from 1Q earnings call on introduction of fixed making charges

"Partly, because what happens is in many markets, and especially small towns, people are still used to getting a making charge in terms of fixed rupees per gram and they are expecting Rs400 - Rs 500 per gram. Now suddenly, when the gold price has gone up and they start seeing Rs 1,000 a gram because of the percentage basis, to that extent. And therefore, we have introduced a few KVIs now in the fixed rupees per gram, but bulk of our plain gold is sitting in the percentage itself. So to some extent, yes, that is true, and there could be a dilution on that account. But it may be, as I said, 0.1%, 0.2% on the A&P, not very material or not very large, that can't be overcome".

- Historically, significant margin expansion had happened post shift to 'percentage of gold making charges' structure: We note that Tanishq had shifted to a percentage of gold price making charge structure in FY09. Prior to this shift, Tanishq's EBIT margin ranged between 4-7% over FY03-08. Profitability has since then improved significantly to c.12% by FY20 (see chart 1). Linking making charges to gold price had resulted in Tanishq benefitting from the 9% gold price CAGR over FY09-20 (see chart 2 for EBIT per 10gm trajectory over FY07-20).

- Implications of shift to 'fixed price making charge' structure: Introduction of fixed making charges, even though a small proportion currently, is something that we will watch carefully given that a potential shift to fixed price making charge could significantly reduce operating leverage and limit the business' gross profit expansion.

- Valuation and risks: Our earnings estimates remain unchanged; we model revenue / EBITDA / PAT CAGR of 14 / 12 / 15 (%) over FY20-22E. Maintain HOLD with a DCF-based unchanged target price at Rs1,100. At our target price, the stock will trade at 49x P/E multiple Mar-22E. Key upside risks is faster-than-expected recovery in studded share leading to margin support and key downside risk is potential shift to fixed making charges that could limit long-term benefits from operating leverage.

Shares of Titan Company Limited was last trading in BSE at Rs.1135.95 as compared to the previous close of Rs. 1126.45. The total number of shares traded during the day was 114217 in over 4432 trades.

The stock hit an intraday high of Rs. 1142.45 and intraday low of 1129.4. The net turnover during the day was Rs. 129744616.

Source : Equity Bulls

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