Despite a weak quarter, PC Jeweller has a long runway for growth, a strong balance sheet, franchise value of two, and owner operators as managers. Earnings should grow by 100% over the next five years without productivity improvements. As the demand returns and regulatory headwinds dissipate, in addition to earnings growth, PC Jeweller could see substantial multiple expansion between 100% to 200%.
PC Jeweller reported its Fiscal Quarter 1 2015 results on August 8, 2014. The company continued its showroom expansion in the quarter increasing its showroom count by three to 44. Since the end of the quarter, PC Jeweller opened an additional showroom and increased the FY2015 showroom target to 60 from the previous target of 56.
PC Jeweller’s total revenues dropped by 4% compared to FQ1 2014. Domestic sales dropped by 30% despite a 30% increase in square feet. Export sales picked up the slack increasing by 169% year on year.
Clearly, PC Jeweller’s performance on domestic sales is a disappointment. The main driver was subdued demand, continued regulatory pressures and a very strong FQ1 2014 due to a significant decrease in the INR gold price in FQ4 2013 (5%) and FQ1 2014(11%). Other jewelry retailers saw similar weakness; Titan Company’s jewelry sales fell by 10%, TBZ saw sales fall by 19% and Thangamayil Jewellery fell by 13%. PC Jeweller underperformed. It is one quarter of underperformance after years of outperformance so not much stock is put into the weakness relative to peers, but the weakness will be monitored. Despite these headwinds, the domestic market is expected to grow by 14% per year over the next five years. Additionally, organized sales only account for 22% of the overall market and should continue to grow at a faster pace than the overall market, Technopak estimates an organized retailers growth rate twice the market rate.
PC Jeweller’s valuation is cheap in both absolute terms and relative terms.
In absolute terms, current earnings are depressed due to demand cyclicality and regulatory headwinds. PC Jeweller should also double its showroom count over the next three to five years with significant opportunities to expand it showroom count after five years. The company’s operating profit and earnings should double over the next five years without any productivity improvements. A company with a multiyear double-digit growth rate and a franchise value of two should trade on at least 15 times maybe even 20 times. Over the next five years, PC Jeweller’s operating profits and earnings should double, while its multiple should expand by 100% to 200%.
On a relative basis, PC Jeweller has the strongest growth over the past five years of the entire listed jewelry retailer. The strong relative growth should continue over the next five years. It also has a ROE well above the peer group average, the strongest balance sheet and owner operators as management, yet it trades at a 50% discount on a PE basis of its closest peer.
PC Jeweller has no corporate governance issues. The company has the largest export business of its peer group, which the market frowns upon due to lower gross margins. Although export business has weaker gross margins, SG&A is significantly lower than domestic SG&A leading to roughly equivalent operating margins and asset turnover. Over the past four years, export operations operating margins averaged 8% with an average asset turnover of 1.5,while domestic operating margins averaged 9% with an average asset turnover of 1.5 times.
Another problem weighing on valuations is anchoring of analyst forecasts. Analyst target prices are anchored on existing valuations. Analysts’ target price for PC Jeweller is determined using FY2015 PE multiple of 6.5, despite the strength of the business and growth outlook with no reason provided for the low PE. Titan’s target price is based on a FY2015 PE multiple of 40 times. Titan warrants a premium given the strength of the company operations, the strength of brands, and its size, but a 600% multiple premium to PC Jeweller is probably a bit too much of a disparity. TBZ has weaker returns, higher debt and a weaker growth outlook but analyst has a target PE multiple of 15 times. PC Jeweller should be trading closer to Titan. Using a conservative 50% discount to Titan and a 33% premium to TBZ, a PE of 20 is warranted meaning potential multiple expansion of 200%.
PC Jeweller has a long runway for growth, a strong balance sheet, franchise value of two, and owner operators as managers. Earnings should grow by 100% over the next five years without productivity improvements. As the demand returns and regulatory headwinds dissipate, in addition to earnings growth, PC Jeweller could see substantial multiple expansion between 100% to 200%.