Slack demand leading to lower cash accrual, elevated inventory levels and curtailed bank finance will lead to moderately negative credit outlook for gold jewellery retailers this fiscal and hard-brake store expansion, an analysis of 92 of them rated by CRISIL, which account for ~40% of sector revenue, shows.

The number of new store additions is expected to reduce to almost a third of the average between fiscals 2017 and 2020. Consequently, capital investments¹ will be ~70% lower at Rs 650-700 crore this fiscal compared with the average of the past four fiscals.

Cash accrual is expected to decline ~40% on-year, given an expected 35-40% fall in sales volume for the industry – the steepest on-year drop in more than a decade – despite higher gold prices (refer annexure). Sales volume would plunge because of curtailed discretionary spending following the Covid-19 pandemic, stores remaining shut for most of the first quarter, and intermittent lockdowns in some states in the second quarter.

Overall revenue would drop an average 20-25% this fiscal. However, operating profitability will see only a limited decline of 100-150 basis points to 4.2-4.7% for three reasons: one, operating leverage is currently low with fixed costs accounting for less than 10% of the total costs; two, players are undertaking cost-optimisation measures, including renegotiating rentals, curtailing employee costs, and reducing promotional expenses; and, three, the surge in gold prices affords room to run tactical promotions such as lower jewellery making charges to prop up revenues without significantly impacting margins.

Says Mohit Makhija, Director, CRISIL Ratings, “The dent in cash accrual will be material given the fall in absolute profit because of the sharp decline in revenue. That, along with increased inventory holding owing to a sharp decline in sale volume – and despite lower store expansion – will affect the credit metrics of jewellers. Interest coverage is expected to be 2.9 times compared with 4.2 times last fiscal.”

As for availability of finance, bank lending to the gems and jewellery sector declined 17% over the 12 months through July even as gross bank credit rose 7%. Given the series of delinquencies and asset quality issues the sector has witnessed over the past few years, banks have been cautious about renewing and enhancing funding limits.

Recovery in gold jewellery demand is expected to be gradual and start with the upcoming festive and wedding seasons. Wedding jewellery accounts for 55-60% of demand and postponement of marriages because of the pandemic means pent-up demand will manifest later. Besides, the wallet share of jewellery purchases in overall wedding expenses would have increased because of savings on costs such as banqueting in view of social-distancing norms.

Says Gautam Shahi, Director, CRISIL Ratings, “But even if demand recovers, gold jewellery retailers are unlikely to be enthused enough to increase stores in the second half of this fiscal because of elevated inventory levels and curtailed bank credit. We believe retailers will focus more on consolidating operations of stores in Tier I cities, where the ticket sizes are much bigger than that in Tier II and III cities.”

Next fiscal, we foresee a material recovery in the performance of gold jewellery retailers. However, as the impact of the pandemic wanes, gold price fluctuations, changes in import duty, and enhancement in bank funding for the sector will be the monitorables.

¹(Investment considered at Rs.22 crore/store for an average store area of ~2000 square feet and includes cost of fit-outs, furnishing, interiors and inventory)