Recommendation: Buy.
The firm is
significantly undervalued using absolute (DCF) and comparable company analysis
(P/E, EV/EBITDA) methods. It is also an extremely well managed firm with the
best ROE’s and same store comparables in the industry. We also considered
various sensitivity scenarios and worst case scenario valuation but the current
market price is lower than our valuation in each and every one of those
scenarios. This is an excellent stock from an asymmetrical risk/return
perspective having very low downside and a significant upside potential.
Finally, this report also outlines reasons why the street is pricing it at such
a low valuation and what are some of the catalysts that provide a path to the target
valuation of this firm.
Investment
Thesis
1) 
Valuation: FCFE/DCF valuation for
Thangamayil is Rs. 398 using a long term cost of equity of 16.2% and a
growth in perpetuity of 4%. Short term CAGR for the model is 10% which is way
below its historical or expected growth rate for the next few years. We expect an EPS of Rs. 65.4 for the
year ending March 2013 including the
assumption that the firm will issue equity to fund expansion. At it’s
current quote, the firm is trading at 3.1x current fiscal’s estimated earnings
with an EPS growth of 52%. At our price target of Rs. 398, it will trade at 6x
current fiscal’s estimated earnings which is in-line with valuation of other
branded jewellers in India.
Valuation: FCFE/DCF valuation for
Thangamayil is Rs. 398 using a long term cost of equity of 16.2% and a
growth in perpetuity of 4%. Short term CAGR for the model is 10% which is way
below its historical or expected growth rate for the next few years. We expect an EPS of Rs. 65.4 for the
year ending March 2013 including the
assumption that the firm will issue equity to fund expansion. At it’s
current quote, the firm is trading at 3.1x current fiscal’s estimated earnings
with an EPS growth of 52%. At our price target of Rs. 398, it will trade at 6x
current fiscal’s estimated earnings which is in-line with valuation of other
branded jewellers in India.
2) 
Asymmetrical
Risk/Reward: Thangamayil is trading at Rs. 205 and yielding 3.9% (TTM). So, on the downside,
on a two year horizon basis, the stock would have to be down by 7.8% (to Rs. 189)
for us to start losing money on this stock if the company simply keeps its
current dividend. Moreover, at Rs. 189 (7.8% down scenario) we break even and
the stock will yield 4.2% (Rs. 8 = TTM, current annual dividend). On the other
hand, the upside is a capital gain of 94% + 7.8% two year dividend yield for a
total return of 101.8%. Even if we consider a 0.5 probability of 102% return
the upside would be 51%. While for a 51% downside from the Rs. 191 break even
price, the stock would have to be at Rs. 93. The last time the stock was at
that level was in May 2010 when its EPS was 1/4th its current TTM
EPS. So, the probabilty of the stock trading at Rs. 93 is extremely low and
hence we consider this stock as having an assymetrical risk/reward ratio over a
two year horizon.
Asymmetrical
Risk/Reward: Thangamayil is trading at Rs. 205 and yielding 3.9% (TTM). So, on the downside,
on a two year horizon basis, the stock would have to be down by 7.8% (to Rs. 189)
for us to start losing money on this stock if the company simply keeps its
current dividend. Moreover, at Rs. 189 (7.8% down scenario) we break even and
the stock will yield 4.2% (Rs. 8 = TTM, current annual dividend). On the other
hand, the upside is a capital gain of 94% + 7.8% two year dividend yield for a
total return of 101.8%. Even if we consider a 0.5 probability of 102% return
the upside would be 51%. While for a 51% downside from the Rs. 191 break even
price, the stock would have to be at Rs. 93. The last time the stock was at
that level was in May 2010 when its EPS was 1/4th its current TTM
EPS. So, the probabilty of the stock trading at Rs. 93 is extremely low and
hence we consider this stock as having an assymetrical risk/reward ratio over a
two year horizon.
3) 
Worst
Case Scenario: DCF analysis is sensitive to long term cost of equity and growth. Scenario
analysis for various cost of equity above our estimated long term cost of
equity (16.2%) and a decline in dividend growth below our estimated short term
growth rate of 10%. The scenario analysis shows that value of the stock at 1% short
term growth and 22.2% long term cost of equity is Rs. 219. The current quote is
even below this worst case scenario. We can always debate about the cost of
equity to be used for this firm; however, the firm’s three year debt trades at
12.5% and hence a cost of equity of 22.2% would be 78% above its cost of debt
and would be an extremely high cost of equity. If we just use the 6% GDP growth
as a proxy for this firm’s growth and using the highest cost of equity of 22.2%
from our scenario analysis, we get a value of Rs. 266.
Worst
Case Scenario: DCF analysis is sensitive to long term cost of equity and growth. Scenario
analysis for various cost of equity above our estimated long term cost of
equity (16.2%) and a decline in dividend growth below our estimated short term
growth rate of 10%. The scenario analysis shows that value of the stock at 1% short
term growth and 22.2% long term cost of equity is Rs. 219. The current quote is
even below this worst case scenario. We can always debate about the cost of
equity to be used for this firm; however, the firm’s three year debt trades at
12.5% and hence a cost of equity of 22.2% would be 78% above its cost of debt
and would be an extremely high cost of equity. If we just use the 6% GDP growth
as a proxy for this firm’s growth and using the highest cost of equity of 22.2%
from our scenario analysis, we get a value of Rs. 266.
4) Why is the street valuing it so low:
A few reasons why the
market may be pricing it at such a low valuation:-
a. Equity Issuance: The firm has indicated that it is considering
issuing equity in the next one year. This may be a concern for investors only
if the company issues stock at a discount to the market. However, given the low
valuation it is highly likely that the company could do a PIPE deal at a
premium to its market price.
b. Low Liquidity & No analyst coverage: The average 90 day volume for this stock is 20,000 shares and considering
a 20% max daily limit to build/liquidate a large position, an institution would
only be able to buy/sell 4000 shares on a daily basis making it very difficult to
build or liquidate a large position. For the same reason, there is almost no
major brokerage covering the stock. However, the firm has indicated that it is
considering issuing equity which will increase liquidity and attract
brokerages.
c. Commodity exposure: The firm’s inventory stands
at 78% of total assets which comprises gold and gold jewelry. A sudden sharp
and sustained drop in gold prices could have material impact on its inventory
value. As of March, 2012, its inventory was Rs. 3.7B which is significantly
higher than its current market cap of Rs. 2.8B. Moreover, as the company keeps
opening new showrooms this inventory is likely to increase. As the firm doesn’t
hold gold for trading purposes, it is unlikely that a loss in inventory value
would hit EPS but it could quickly deplete the book value of Rs. 1.46B.
5) Growth Prospects: We expect an EPS of Rs. 65.4 for the
year ending March 2013 including the assumption that the firm will issue equity to
fund expansion. At it’s current quote, the firm is trading at 3.1x current
fiscal’s earnings with an estimated EPS growth of 52%. The firm plans to open
12 more stores before March 2013 for a total of 27 stores. Tamilnadu has 32
districts and so even if the firm opens one branch per district it still has
more room for growth in 2014 before it has to venture into neighboring states
of Kerala and Andhra Pradesh. Thangamayil is based out of Madurai and so Kerala
seems to be natural choice when expansion outside Tamilnadu may be contemplated
in the 2015 time frame. Moreover, according to Kerala Jewelry Manufacturers
Association, Kerala consumes 20% of India’s gold for Jewelry which further
strengthens the case for expansion in Kerala.
6) Peer Comparison:
a. Same Store Comparison: Sales and subsequently PAT
for Gold retailers depend largely on the inventory they maintain for every
store, we compared Thangamayil’s peers on a same store basis. Inventory/Store
for the firm is comparable to the industry leader Titan and so is sales/store.
PAT/Store is lower compared to Titan but is almost equal to its peer in size
TBZ with much lower inventory/store when compared to TBZ.
 |
b. Valuation & Profitability: From a valuation
perspective (PE, EV/EBITDA) Thangamayil is much better compared to its peers
such as Gitanjali and TBZ. Profitability of the firm is in-line with the best
company in the industry and its much larger peer Titan. It also has better
interest coverage ratios compared to Gitanjali and TBZ.
 |
7) 
Same Store Efficiency: Same store sales declined at
a CAGR of 8.6% for the three years ending March 2012, even though gold prices
rose at a CAGR of 25.7%. Gold sales per store decreased at a CAGR of 28% in the
last three years to 155 kg/Store. However, Gold inventory per store for the
same period declined at a CAGR of 21.5% to 58.7 kg/store and PAT/store
increased at a CAGR of 3.5% to Rs. 246 lakhs per store. An increase in
PAT/store inspite of a decline in gold inventory per store indicates the
company is improving its margins and using less working capital (inventory) to
generate higher returns per store.
Same Store Efficiency: Same store sales declined at
a CAGR of 8.6% for the three years ending March 2012, even though gold prices
rose at a CAGR of 25.7%. Gold sales per store decreased at a CAGR of 28% in the
last three years to 155 kg/Store. However, Gold inventory per store for the
same period declined at a CAGR of 21.5% to 58.7 kg/store and PAT/store
increased at a CAGR of 3.5% to Rs. 246 lakhs per store. An increase in
PAT/store inspite of a decline in gold inventory per store indicates the
company is improving its margins and using less working capital (inventory) to
generate higher returns per store.
8) 
Profitability & Sensitivity: ROA & ROE has increased
over the last four years as a result of increasing net profit margin, asset
turnover and leverage. Additionally, every 100 basis points reduction in
interest rates adds 26 basis points to net profit margin. We expect this to
help in 2012-2013 fiscal year as we see have already seen a 50-75 basis points
of reduction in short term rates.
Profitability & Sensitivity: ROA & ROE has increased
over the last four years as a result of increasing net profit margin, asset
turnover and leverage. Additionally, every 100 basis points reduction in
interest rates adds 26 basis points to net profit margin. We expect this to
help in 2012-2013 fiscal year as we see have already seen a 50-75 basis points
of reduction in short term rates.
Industry Analysis
Ø Inventory
Management is key to success of any Gold Retailer
o
Gold
comprises most of a Jewelers inventory and inventory is about 80% of the total
capital required for a Jeweler. Thangamayil’s hub-spoke model with quick
delivery of ornaments to smaller stores drastically improves inventory
management and provides a significant advantage compared to the family owned Jewelers.
Ø Branding and Distribution are key
competitive advantages; difficult for new entrants to gain market share
o
Even
highly educated customers find it difficult to gauge the value of Jewelry and
so they rely on trustworthy Jewelers to make that decision; Thangamayil is
slowly but definitively occupying a mindshare of Tamil consumers which could
last for generations and it would be difficult if not impossible for
unorganized retail Jewelers (90% of the market) to compete with Thangamayil.
o
Trust
in Jewelers is the most important part of a customer’s decision; brand-building
is at the core of this and as the number of stores increase the acquisition
cost per customer declines exponentially.
o
The
long term prospects of survival of a Jeweler are also important since a lot of
customers exchange Jewelry; offering a chain of stores for a customer’s
convenience alleviates this issue to quite an extent.
Ø Consumers are price inelastic to a certain
extent owing to brand recognition and trust in Jewelers
o The price of gold is the same at any
Jeweler and so the only variable is the cost of manufacturing & selling
Jewelry; in this case centralized procuring could leverage economies of scale.
Ø Organized Retail Jewelry is a growing
market in India
o
In
almost all western countries, 70% of the population lives in urban areas; as
India is globalized, population growth in old/new urban areas is bound to
increase, a disadvantage for the traditional unorganized family-Jeweler based
model.
Ø Business model has high operational leverage
o
Setting
up a chain of Jewelry stores and a brand entails high fixed costs; a major
barrier to entry for new firms exploring this segment.
