The current article aims to highlight the key aspects of the business of gems and jewellery retailing companies. After reading this article, an investor would understand the factors that impact the business of gems and jewellery retailers and the characteristics that differentiate a fundamentally strong gems and jewellery company from a weak one.
Key factors influencing the business of gems and jewellery retailing companies
1) Low pricing power of gems and jewellery retailers due to intense price-based competition in the fragmented industry dominated by unorganized players:
The gems and jewellery retailing market is highly fragmented because it is primarily dominated by family stores where multiple generations of owners are involved in this business. Most of these businesses are single outlet stores.
As per the credit rating agency, ICRA, unorganized players make up 65% of India’s jewellery retailing segment.
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While organised trade is increasing, the industry remains dominated by unorganised players that account for around 65% of the market (which has reduced from ~85%, a decade back).
Even though, in recent years, the share of organized players like Tanishq (Titan Company Ltd), Kalyan Jewellers, Malabar etc. has increased. However, still, this segment is highly fragmented, which leads to intense competition among the players to gain business.
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given the highly fragmented base, competitive intensity tends to be high.
Another factor that erodes the pricing power of gems & jewellery retailers is the ease with which nowadays customers can compare prices across different shops and marketing channels like online retailing.
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easy pricing comparability on the part of customers which leads to significant price competition.
As a result, almost all retailers have to offer the best price to the customers to gain their business and retain them.
In addition, the business activity of gems and jewellery retailers does not have a lot of value addition, which leads customers to easily switch from one retailer to another. As a result, gems and jewellery retailers face a lot of pricing pressure, which leads to low-profit margins.
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industry is characterised by…moderate profit margins with limited product value addition, besides pricing pressures, given the intense competition.
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The jewellery retail industry operates on relatively moderate profit margins
Also read: How to do Business Analysis of a Company
2) Volatility in earnings of gems & jewellery companies:
Profit margins and earnings of jewellery retailers fluctuate significantly over time. Let us understand some of the prominent factors leading to such volatility.
2.1) Dependence on international gold prices:
The key raw material for gems & jewellery retailers is gold, whose prices are benchmarked to international gold prices. As a result, all such retailers are exposed to sharp cyclical fluctuations in gold prices.
Moreover, due to low pricing power, retailers are not able to immediately pass on the increase in gold prices to customers due to fear of a decline in demand as well as customers switching to competitors.
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Given the intensifying competition, the pricing flexibility of jewellers is limited, exposing earnings to price risks.
This inability to freely pass on increases in gold prices along with a moderate profit margin of jewellery retailers due to low value-addition, makes their profits/earnings highly volatile.
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Jewellery retail operations involve relatively low value addition and hence, the profitability is exposed to the fluctuation in international gold prices.
Also read: How to do Financial Analysis of a Company
2.2) Exposure to foreign exchange fluctuations:
Due to the direct impact of international gold prices, gems & jewellery retailing companies also face the impact of foreign exchange (forex) fluctuations where any movement in the price of the India Rupee (INR) against major international currencies esp. the US Dollar (USD) impacts the import parity price of gold in India.
As a result, almost all the retailers are impacted by forex fluctuations whether it is by the import of raw gold (bullion), or the export of gold jewellery. In addition, players opting for financing options like gold metal loans are also exposed to forex fluctuations, which adds to the volatility of gems & jewellery retailing companies.
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Foreign currency exposure for jewellery retailers primarily arises from – [i] direct import of gold (allowed under special approval), [ii] export of jewellery, and [iii] liability on metal gold loans
2.3) Seasonal fluctuations in the demand for jewellery:
Demand for jewellery especially gold ornaments faces seasonal variations.
Rural areas form a large source of demand for gold jewellery because, first, such areas have comparatively lower access to financial instruments of savings and second, people may not be very comfortable in investing large amounts in financial instruments, in turn, preferring to invest in gold and real estate.
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major portion of the jewellery demand originates from the rural sector, where gold is considered an effective means of investment.
Rural demand for gold depends on factors like the monsoon, the success of crop production etc., which bring in periods of high demand following successful crop harvest, marriage calendars etc. leading to seasonality.
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While reasons including healthy monsoon driving rural income and marriage / festive calendars have driven seasonality over the past few years,
Due to a large dependence on rural demand, many natural factors like the performance of monsoon, crop damages like pests, drought etc. impact the business of gems & jewellery retailers.
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A good monsoon, resulting in higher farm output, typically translates into favourable jewellery demand.
there exists an indirect risk of rural demand for jewellery moderating during periods of crop loss, caused by physical climate change, or otherwise.
Due to low-value addition and easy switching of customers from one retailer to another, it becomes essential that gems & jewellery retailers spend a significant amount of money on branding, advertisement, and promotions to keep attracting customers to face seasonal and economic slowdowns.
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Retailers with stronger brand equity also tend to tide over economic shocks to an extent, irrespective of their positioning (economy or premium segment)
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it is critical for retailers to create unique positioning in the market through brand promotions and/or advertisements.
Also read: How to analyse New Companies in Unknown Industries?
3) High regulatory risk faced by gems & jewellery companies:
Gems & jewellery retailing sector sees frequent regulatory changes and policy implementations primarily due to two factors.
3.1) Control of imports and current account deficit:
India is a large consumer of gold; however, it produces a very small amount of gold. As a result, most of the gold consumed in India is imported.
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Despite the lack of domestic production from mines in India, the availability of gold bullion has not been a concern as these are largely supported by imports.
As a result, gold constitutes a large share of India’s imports and leads to a significant outflow of foreign exchange (forex) reserves. Therefore, govt. tries to control the import of gold in India by appointing banks and other nominated agencies as channels of purchasing gold for gems & jewellery retailers.
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Gold supply in India is regulated and jewellery retailers primarily rely on banking channels as well as nominated agencies for procurement of raw material, i.e. gold bullion.
Whenever India faces a large current account deficit (i.e. forex outflows are more than inflows), the govt. takes steps to control the import of gold into the country. Such steps have included the imposition of import duty as well as the mandatory export of a portion of gold imported by companies in India.
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gold is one of the key items imported in the country, any policy decisions relating to managing the current account deficit (CAD) impacts gold supply. For example, restriction on bullion imports in 2014 (…under the 20/80 scheme)
As, many times, changes in govt. policies put constraints on the availability of gold, therefore, gems & jewellery retailers with diversified avenues of gold sourcing are at an advantage like recycled gold, imports from multiple countries etc.
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As policy measures can result in short-term supply-side concerns, diversified sourcing supports business continuity.
3.2) Controls over cash transactions/black money:
Gems & jewellery sector is dominated by the unorganized sector where a sizable portion of transactions take place in cash. As a result, govt. keeps tightening its policies in order to restrict black/unaccounted money.
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The jewellery retail sector is characterised by many unorganised players and involves a sizeable share of cash transactions. To curb unaccounted money…periodic policy interventions by the Government and regulators have been seen over the years.
To control black money in the gems & jewellery segment, govt. has taken additional steps like mandatory submission of permanent account number (PAN) details when purchasing jewellery for more than ₹2 lahks.
In addition, govt. keeps on implementing measures to control the demand and supply of gold like duties and taxes, certifications etc.
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include imposition of import duty, excise duty [now subsumed under the Goods and Service Tax (GST)], regulation on jewellery savings schemes, restriction on supply of gold metal loan (GML), disclosure of permanent account number (PAN) card details for transactions over Rs. 2.0 lakh and mandatory hallmarking among others.
Also read: Credit Rating Reports: A Complete Guide for Stock Investors
Therefore, investors in gems & jewellery retailing companies should continuously monitor policy changes implemented by govt. because these significantly impact the business of these companies.
4) Capital-intensive nature of business:
Gems & jewellery retailing companies have to buy an expensive raw material (gold) and then keep it as inventory with numerous designs of ornaments, which may stay unsold for a significant amount of time.
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Such companies have substantial physical inventories of jewellery
As a result, these companies require a large amount of working capital to fund inventory purchases and storage.
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industry is characterised by high working capital intensity.
As gems and jewellery retailers have to keep a large amount of expensive inventory, which puts a substantial cost burden on their operations; therefore, retailers tend to be as efficient in their inventory management as possible so that they may reduce their costs. Better inventory management adds to their profit margins.
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The operating efficiency is measured through stock rotations and inventory management practices…ability to maintain high inventory churn by effecting granular control over stock movement within and across stores with the aid of management information systems (MIS).
Also read: Inventory Turnover Ratio: A Complete Guide
Traditionally, gems & jewellery retailing operations have been only working capital intensive and not fixed-capital intensive, which was not a big concern for lenders because the working capital facilities were secured by the inventory of gold ornaments, which is a highly liquid and easily sellable asset.
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highly liquid nature of the gold inventory held by the retailers, with jewellery/gold being a readily marketable commodity.
However, nowadays, retailers have started expanding their number of stores, which has made their operations fixed-capital intensive as well.
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Further, with same-store sales growth limited by competitive factors, retailers have been investing in new stores to sustain growth in sales volume, leading to rising capital intensity in the business.
Moreover, a continuous change in customers’ preferences requires jewellery companies to continuously invest money in new product designs, which increases the capital-intensiveness of the business.
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In the jewellery retail industry, entities are vulnerable to competitive pricing pressures and shifts in buying patterns of end markets, mandating steady investments in continuous development of new product designs, marketing and management of inventory and supply chain.
Also read: Asset Turnover Ratio: A Complete Guide for Investors
The capital-intensive nature of business increases the fixed costs of operations. This, in turn, increases the fluctuations in the earnings and profit margins for gems and jewellery retailers further.
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The high levels of fixed cost and asset investment amplify the bottom-line impact of variations in realizations.
The increasing capital-intensive nature of jewellery retailers makes them highly dependent on funding from banks for expansion of operations because due to the involvement of cash transactions/unaccounted money, public markets do not look at jewellery retailers enthusiastically.
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Jewellery retailers are highly dependent on the banking system to meet their working capital needs and have relatively limited access to capital markets.
In the past, gems and jewellery retailers have faced tough times when banks restricted the credit flow
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In the recent years, availability of bank credit has emerged as a new risk. Banks’ lending to the gems and jewellery sector have turned cautious, given the concerns on corporate governance-related issues in the sector over the past few years.
As a result, the expansion plans of many jewellery retailers suffered a setback.
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With the lending environment turning cautious, store expansion plans of many retailers were put on hold.
Therefore, investors should be cautious while assessing the expansion plans for gems and jewellery retailing companies because any untoward incident related to one company may impact the entire sector. For example, the frauds conducted by two famous jewellers, Neerav Modi and Mehul Choksi in 2018, tightened the credit flow to the entire gems & jewellery sector.
Liquidity crisis for gems, jewellery sector as Nirav Modi case scares banks: Business Standard
5) Large-scale operations help gems and jewellery retailers:
Due to intense competition, low-value addition and low pricing power, gems & jewellery retailing companies suffer from low-profit margins. In such a case, companies usually resort to many strategies to gain competitive advantages as well as to protect and improve their profit margins. One such strategy is to increase the size of operations to benefit from economies of scale.
Retailers with large sizes of business have a higher bargaining power over suppliers like bullion suppliers, bankers etc. As a result, they get cost advantages in their operations.
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Scale also imparts cost benefits in procurement, helping retailers gain a pricing advantage in the highly competitive business.
In addition, large gems & jewellery retailers can spread their fixed overheads like administrative, corporate headquarter expenses etc. over a large revenue leading to improvement in profit margins (economies of scale benefits).
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Larger companies would also be able to better leverage their fixed operating expenses…enhancing operating performance returns including higher operating margins and return on investment.
Retailers with a large scale of business have better access to resources like funding, talent, and raw material, which helps in stable operations of the business across economic cycles.
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Scale also provides flexibility to make investments that lead to growth and expansion into new markets, with companies of a larger scale also possessing better access to financial markets for funding growth plans.
Large retailers can also afford to have integrated operations where they manufacture their own ornaments instead of outsourcing. As a result, they can capture a higher share of the value chain leading to better profit margins. Due to their own manufacturing, they are able to respond quickly to changing customer preferences by changing their designs.
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Jewellers with integrated presence across manufacturing enjoy better value addition and can adapt to changing consumer demand trends
Also read: Operating Performance Analysis: A Simple & Complete Guide
6) Diversification strengthens the business model of gems & jewellery retailers:
In order to deal with the fluctuations in profit margins/earnings, retailers usually diversify their business along different lines like product range, geographical, business segments, procurement etc.
Diversification of product range brings more customers to the shop, which increases sales and brings resilience during tough periods.
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Footfalls in the highly competitive jewellery retail industry are driven by the availability of a wide assortment of jewellery.
Product diversity with a presence in value-added/studded jewellery also helps in getting higher profit margins.
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…requires higher product variety to sustain the footfalls. Product diversity also aids margin expansion, where presence in value-added jewellery shields the earnings of jewellers
If a retailer is able to have an exclusive set of jewellery designs, then it can get customer loyalty and premium pricing for its products leading to higher profit margins.
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maintain the exclusivity of designs sourced, as it enables them to create a unique market position and justifies premiums in terms of pricing.
Jewellery companies with multiple stores in different geographical markets are protected from a decline in regional demand due to poor monsoons, crop failure etc.
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geographical diversification reduces a retailer’s vulnerability to (i) variability in demand in a single region, and (ii) demand disruptions caused by force majeure events in a single geography.
Though geographical diversification also brings the challenge of catering to different consumer preferences like plain gold jewellery in South India in contrast to a preference for value-added/studded jewellery in other parts.
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For the jewellery sector, the customers’ preference for the product…vary across geographies – where retailers in South India sell higher share of plain gold jewellery than the studded variety and vice versa in other parts of India.
In the light of increasing capital intensity of business due to the requirement of opening multiple stores in different areas, gems & jewellery companies have started going for leased stores as well as franchise models. It provides an asset-light approach to business expansion. In addition, the franchise route also reduces the inventory/working capital burden on the company.
As a result, a higher share of leased and franchise stores reduces the capital burden on companies.
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nature of stores…owned, leased and franchise route…Especially by operating through the franchise mode, retailers managed to reduce their operating costs and, in a few cases, mitigated the inventory carrying risks.
Apart from focusing solely on retailing operations, many times, gems & jewellery companies also start trading operations in gold to reduce the volatility in their earnings. Even though, trading operations reduce volatility in earnings; however, they reduce profit margins as well because trading in gold is a very low value-adding activity.
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While trading business can help boost revenues during periods of demand slowdowns, the profitability of such operations remains low due to low value added nature of the business.
In addition, gold trading operations usually involve a high credit period to customers, which increases the risk of default. As a result, it becomes essential for such gold traders to diversify across multiple customers to avoid the concentration of counterparty risk.
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trading operations, credit period extended to customers (mostly other retailers) can be high and trading revenues volatile. A diversified customer base is key to minimize counter party credit risks
Also read: Receivable Days: A Complete Guide
Like diversification of customer base, it is essential for gems & jewellery retailers to diversify in sources of gold purchases because govt. policies may restrict the supply of gold from banking & nominated agencies channels.
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a sound procurement policy is crucial to ensure business continuity in the wake of supply side constraints arising out of economic shocks and/ or regulatory risks.
7) Ratios to analyse the business of gems & jewellery retailers:
As discussed in the business analysis of organized retail companies, every retail store of gems & jewellery retailing companies represents a fully functional unit. Therefore, store-level analysis of business helps an investor to understand the strength of the business model of the company.
To understand the store-level business performance, an investor needs to focus on the following parameters:
- Same-store sales growth
- Store level contribution of profitability
An analysis of same-store sales growth is essential because otherwise, a retailer may continue to show overall growth in business by continuously focusing on opening new stores and in turn, may mask the weakening competitive position of existing stores. Only when an investor analyses same-store sales growth, then she might uncover the declining business of individual stores.
Store-level performance is further broken down into per-customer parameters to further do a granular analysis:
- Number of customers
- Spending per customer
- The average price of products sold
- Number of products sold per customer
There are other parameters, which provide store level deeper understanding of the business dynamics of retailers:
- Rental per square feet vis-à-vis sales per square feet, the rental cost to total sales
- Capital expenditure per square feet
- Debt per retail outlet
- The proportion of stores that have achieved break even, time to break even for new stores
- Growth in footfalls, conversion rate
- Average selling price, average transaction size
- The proportion of sales under the customer loyalty program
- Revenue contribution from studded/value-added jewellery
In addition, due to large inventory requirements leading to working capital-intensive operations, an investor should always assess operating efficiency ratios like inventory turnover ratio, cash conversion cycle etc.
Also read: How to do Business Analysis of Organised Retail Companies
Summary
Gems & jewellery retailers face intense price-based competition among both organized and unorganized players due to limited value addition and the easy switching ability of customers. As a result, companies have low pricing power and work on thin profit margins.
The business of jewellery retailers is significantly influenced by international gold prices and foreign exchange rates, which are very volatile. As a result, the profit margins and earnings of companies are highly volatile.
In addition, earnings of jewellery retailers show seasonal variations with peak sales in marriage seasons, post-harvest seasons etc. Most of the demand for jewellery is from rural areas where the availability of financial investments is low. Therefore, factors impacting rural demand like the performance of monsoons, crop failure, natural calamities etc. significantly influence the business of gems & jewellery retailers.
India imports most of its gold requirements. Therefore, whenever, India faces large current account deficits resulting from excessive forex outflows, then the govt. puts curbs on gold imports. To control the availability of gold in the country, the govt. has mandated the purchase of raw gold (bullion) by jewellery makers from banks and nominated agencies.
Apart from forex outflows, gold purchases involve significant transactions in cash/unaccounted money, which further increases the scrutiny of the sector and increases regulatory risk.
The business of jewellery retailers is capital-intensive as they need to keep a large inventory of gold ornaments of different designs, which may remain unsold for a long time. Frequently changing customer preferences puts an additional working capital burden on retailers as they must keep a large collection of designs to attract customers.
Additionally, retailers need to diversify into multiple stores for growth as well as to reduce the risk of demand slowdown in one geography. The growth of retail chains has increased fixed investment requirements in the sector.
Capital intensity has increased the dependence of retailers on banking channels as such companies have limited access to capital markets. As a result, if banks become cautious of lending to the sector, then their growth plans as well as day-to-day operations suffer.
Among all these challenges, gems and jewellery retailers attempt to strengthen their business model by increasing the size of their operations and, in turn, benefit from economies of scale. Large retailers get cheaper prices from their suppliers, spread their fixed costs over larger operations, and have more financial flexibility leading to lower costs and, in turn, higher profits.
Large retailers also go for in-house manufacturing (integrated operations) leading to better profits and faster response to changing customer preferences.
Moreover, large retailers are also able to benefit from diversification in their operations by way of large product catalogues, geographical diversification of stores etc. Large retailers can spend more money on branding, advertisement, and promotions to gain customer mind space. Large brands can go for leased and franchise stores to benefit from lower costs and therefore, higher profit margins.
While analysing gems and jewellery retailers, an investor should monitor regulatory changes closely as these can significantly impact the business. In turn, she should focus on store-level parameters to understand the ground realities of the business.
Therefore, an investor should always keep in mind these multiple aspects of gems & jewellery retailing companies to understand their business position.
- Intense price-based competition leads to low pricing power in a fragmented industry dominated by unorganized players.
- Volatility in earnings of gems & jewellery companies due to low value-addition, dependence on international gold prices and forex movements and seasonal fluctuations in the demand.
- High regulatory risk due to significant contribution to current account deficit as well as a large share of cash transactions.
- Capital-intensive business.
- A large scale of operations brings competitive advantages.
- Diversification strengthens the business model.
We believe that if an investor analyses any gems & jewellery retailing company by keeping the above factors in mind, then she would be able to assess its business properly.
To learn about business analysis of companies involved in organised retail, please read the following article: How to do Business Analysis of Organised Retail Companies
Regards,
Dr Vijay Malik
P.S.
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Disclaimer
Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.
1 thought on “How to do Business Analysis of Gems and Jewellery Retailers”
Very much useful.