India Ratings and Research (Ind-Ra)  in its recently released report on the gems and jewellery industry “maintained a  stable outlook on organised jewellery retailers and a negative outlook on cut and polished diamond (CPD) exporters for FY18”.

The credit ratings agency, quoting World Gold Council figures, noted that India’s gold jewellery demand fell sharply to  a seven-year low in 2016  to 522 MT, thus registering a decline of 22% y-o-y.  “The demand was impacted severely on account of various one-off events such as nationwide jewellers’ strikes in 1Q16 and severe liquidity crunch on account of the Government of India’s (GoI) demonetisation drive in 4Q16,” Ind-Ra said. “Given the backdrop of four months of complete disruption on either the supply or demand side, Ind-Ra believes the fall in consumer demand was caused by idiosyncratic factors.”

However, the agency believes that “the underlying jewellery demand still remains robust”   given India’s strong macro-demographics and the consumer’s affinity towards gold. Ind-Ra forecasts that   demand is likely to bounce back   to above a five-year average of 600 MT in 2017.

Ind-Ra is of the opinion that the Indian Government’s thrust over the last two years to bring about  regulatory changes   “to control illicit trade practices prevalent in the jewellery industry”,  is likely to benefit organised jewellers at the cost of  those in the unorganised domain. 

“Retailers face an overhang of the impending Goods and Services Tax Bill and a higher slab rate may turn out to be demand dampener particularly for the non-wedding segment,” the agency cautioned.

On the other hand, the agency points out,  based on data released by The Gem and Jewellery Export Promotion Council,  CPD exports increased 13% y-o-y to US$ 16.8 billion during 9MFY17, after declining for two consecutive years. “This was because players across the value chain restocked following stock unloading and cautious inventory management in 2015 in response to a slowdown in the consumer demand for diamond jewellery in China and Hong Kong beginning 2H14,” the agency elaborated.

Yet, though  CPD exports have rebounded, the agency believes that midstream players “continue to face headwinds for diamond jewellery demand owing to political and economic environment in key export markets”.

Additionally, the agency notes, the players continue to operate on thin margins and carry the inventory/price risk.

“As expected by Ind-Ra, rough producers continued to lower rough prices by around 5% in 2016, while maintaining production close to 2015 levels (128 million carats) and extending additional flexible purchasing terms to CPD players,” the agency stated. “Ind-Ra expects rough prices to remain stable in 2017, unless CPD prices decline sharply due to muted demand and rough producers are forced to lower rough prices again.”

The agency believes that demonetisation will have a limited impact on  organised retailers     in FY17. This conclusion is based on Ind-Ra’s analysis (based on its sample set)  which indicates a  revenue growth of around 8% y-o-y and improved EBITDA margins of 50 bp to 10.2% in 9MFY17.

“Favourable market dynamics and government regulations are likely to improve organised retailers’ revenue growth to double digits in FY18,” Ind-Ra stated. “EBITDA margins will improve with increasing share of diamond/studded jewellery in the sales mix On the other hand, Ind-Ra believes credit metrics for CPD exporters are likely to remain stretched in FY18 with EBITDA/interest coverage of 2.9x (FY17 Projected: 2.75x-3.0x), given muted revenue growth, low profitability margins, long working capital cycles and a high dependence on bank lines for inventory funding.”