NATIONAL INTEREST: DUMP IT, SELL IT, FORGET IT

Punjab National Bank’s financial trouble with the Nirav Modi jewellery firm could be the beginning of banks’ trouble with the industry. The finances of the listed diamond jewellery companies suggest the industry is in deep financial trouble with no immediate respite in site.

The industry’s combined net sales were down 15.9 per cent year-on-year (y-o-y) during the first half of the current financial year while their net profit (adjusted for exceptional items) was down 18.9 per cent y-o-y during the period. The industry’s financial liabilities, however, continue to grow with interest expenses up 8.3 per cent y-o-y while total borrowings were up 10 per cent y-o-y during the AprilSeptember 2017 period. The poor show in the current fiscal year came on the back of the industry’s equally bad financial performance in the past few years (see chart).

In the past three years, the industry’s combined net sales grew at a compounded annual growth rate (CAGR) of 6.6 per cent while their net profit (adjusted for exceptional gains and losses) declined at an annualised rate of 2.7 per cent. In the same period, the industry’s gross debt grew at a CAGR of 7.4 per cent while their interest expenses declined at an annualised rate of 2.5 per cent y-o-y.

The industry is now technically insolvent, with the market capitalisation of many companies now lower than their debt outstanding. The listed companies combined market capitalisation is now ~41.6 billion against their current gross debt of ~94 billion.

The analysis is based on the annual and first half financials of listed diamond jewellery companies. Some of the companies in the sample include Gitanjali Gems, Tara Jewels, Rennaissance Jewellery, Vaibhav Global, Goenka Diamond, Swaransarita Gems and Lypsa Gems, among others. The sample excludes goldjewellery focussed retailers such as Titan, TBZ and PC Jewellers, among others.

The biggest problem, bankers say, are the industry’s poor financial ratios and poor loan-to-asset coverage ratio. The companies in the Business Standard sample reported return on equity of only 3.2 per cent during the first half of the current fiscal year, down from an average of 5.1 per cent in FY14 and 16.4 per cent in FY12. The industry has little headroom to service its debt with interest coverage ratio (ICR) of 1.6x during first half of FY18, slightly up from 1.5x in FY14 and 2.6x in FY12.

ICR is calculated by dividing a company’s operating profit by its interest expenses and indicates a company’s debt servicing capacity. According to rating agencies, a company with ICR lower than 1.5x is on the threshold of a loan default.

From the bankers’ perspective, the industry has few fixed assets to back up their loans with most of the loan tied up in inventory and sundry debtors (or receivables i.e. the amount due from their customers). Analysts say this leaves banks with little recourse if a company defaults on its loans. “In case of default or bad debts, banks cannot sell fixed assets (plants and equipment) to recover their loan. It’s tough to liquidate inventory as there could be discrepancy in the market and the book value of finished products while sundry debtors could turn easily into bad debts,” said an analyst on condition of anonymity.

The problem is actually acute in the diamond jewellery industry where there is no uniform criteria of inventory valuation unlike gold, whose prices are uniform and widely quoted.