Quantum Information Services Limited Independent Investment Research 29 January, 2005

Titan Industries Limited

Buy
Market data
Current price Market cap Face value (Rs) FY04 Div/share NSE symbol No of shares Free float 52 week H/L Rs 173 (BSE) Rs 7,314 m 10 Rs 1.0 TITAN 42.3 m 49.9 % Rs 199 / 81

Target Price: Rs 250

Investment Rationale Strong brand portfolio: Despite the competition from cheaper imports, huge unorganised market presence (an opportunity again wherein only 40% is organised) and continued pressure on realisations, Titan benefits from a portfolio of strong brands, which it has a track record of building effectively. Sonata, the lower end range of watches, has grown by an estimated 20% in the last two years thus grabbing market share from the unorganised players. Also, adding to its strengths is its nationwide presence of over 7,000 dealers covering 1,580 towns, including 160+ exclusive Titan retail outlets and a chain of around 157 Time Zone outlets. This, we believe, is a barrier to entry. Jewellery a growth driver: Considering the magnitude of gold consumption in India and the presence of large unorganised market with lack of standardization, organised players like Titan (Tanishq) have promising growth prospects. Titans addressable market size is estimated at Rs 100 bn (Source: Titan) of which it had a market share of around 4% in FY04, which we expect will touch 8% by FY07. Sales of this division have clocked a CAGR of 22% in the last five years and we expect this momentum to sustain in the next three years. More importantly, the margins at the EBIT for the jewellery division are showing continuous uptrend and we expect it to continue, albeit at a slower rate.
Our sales and margins assumptions... Watch sales Net margin Jewellery sales

Share price chart

220 170 120 70 20 Jan-00

Apr-01

Jun-02

Sep-03

Nov-04

Rs 100 invested is worth

130 100 70 40 10 Jan-00 Sensex: Rs 120 Titan: Rs 125

(growth) 50%

Apr-01

Jun-02

Sep-03

Nov-04

30%

Shareholding Category
Promoters MFs and FIs FIIs Public Others Total

10%

(%)
50.1% 22.0% 17.7% 6.3% 3.8% 100.0%
-10% FY01 FY02 FY03 FY04 FY05E FY06E FY07E

Report prepared by Quantum Information Services www.equitymaster.com info@equitymaster.com

Precision engineering division to add to growth: This division caters to the component, component assembly and automation requirements of the automotive and aerospace industries. This initiative is estimated to have generated revenues to the tune of Rs 100 m (around 1% of net sales) in FY04. We expect significant growth opportunities in this segment in the next three years. Not only in revenue terms, but also in terms of profitability, this initiative will add to the overall margins of the time products division of Titan. Since this initiative also uses some existing facilities of Titan, asset turnover is also likely to improve.
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Titan Industries Limited

29 January, 2005

Squeeze on working capital: One of the key factors that was impacting net margins was the high interest burden, most of which is directed towards meeting the working capital requirements. Last time in our recommendation on Titan, we had mentioned this as a concern and at the same time indicated the upside from the tightening of working capital. As is evident from the graph below, the company has unlocked significant cash from working capital, which in turn has enabled it to invest in expansion and debt retirement. We expect this trend to accelerate in the next one to two years in line with the stronger cash flow generation possibilities.
(% sales) 80% 60% 40% 20% FY98 FY99 FY00 (Rs bn) 6.0 5.0 4.0 FY01 FY02 FY03 FY04 Working capital to sales

not an encouraging sign for investors. While we believe that the balance sheet will improve in strength, nevertheless, this is a risk to be borne in mind. International operations yet to attain a critical mass: Titans international ventures that involve large capital costs have turned out mixed results. Infact, the company suffered significant reverses in Europe, where it is now trying to make amends by altering its strategy. The swift pace with which it has ventured into international markets gives the impression that there has been a thinning out of resources. Background Titan is India's largest watchmaker (56% of FY04 turnover) with a share of over 50% of the domestic organised watch market. The company diversified into related areas of organised branded jewelry that now account for 44% of sales in FY04. It has been expanding its presence in the international markets and has three subsidiaries catering to European, Middle East and South Asian countries. The company has scaled down its distribution in the global markets, especially Europe. The strategy is to establish itself in select growth countries like Middle East and Europe, and then grow aggressively in the international market.
(% sales) 90% 60% Revenue mix Watches Jewellery

Working capital to reduce further Current assets Total debt

3.0 FY98 FY99 FY00 FY01 FY02 FY03 FY04 30% 0% FY98 FY99 FY00 FY01 FY02 FY03 FY04

Investment Concerns Competition is here to stay: Further lowering of customs duty is likely to result in increased competition from imports. While the international brands are not necessarily a big threat to Titans market share as a whole due to their premium nature, the scope for margin expansion as far as the watches division will be limited due to the huge unorganised market. Not so strong balance sheet: With a debtequity ratio of 3 times in FY04, the ability of the company to invest in its business to pursue its organic growth is limited. Besides, the return on equity at 8.5% and return on assets at 1.5% is Titan Industries Limited

The management set the stage for organised jewellery retailing in the country through a wellcarved niche brand Tanishq. While the entry to jewellery retailing has enabled it to de-risk its business from watches, it has been an uphill task for the company to grow the market for organised retailing. Nevertheless, we believe that the ability to foresee trends, build brands and gain market share over a period of time is one of the core strengths of Titan.

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29 January, 2005

Industry Prospects The Indian watch market is estimated at around 30 m units, of which close to 80% of sales is accounted by the lower-end segment (i.e. the Sonata range). High local taxes, imports from select South East Asian markets, and a multitude of small, local players have rendered organized players uncompetitive. The organised and unorganised mix is estimated at 40:60. On the jewellery segment front, India is one of the largest consumers of gold in the country (850 tonnes). The recycling process in the industry is high at around 35% to 40%. As per the management, lack of standardization in carating, duty evasion and unethical practices continue to plague organised jewellery retailers growth prospects. Though the industry is unlikely to change structurally any time soon, the pace at which Titan has been able to grow its business indicates that organised retailing is gaining pace. In our interaction with the company, the addressable market share is Rs 100 bn where Titan hopes to gain market share over the long-term (total market size is Rs 450 bn). Valuations The stock currently trades at Rs 173 implying a price to earnings multiple of 9.3 times our FY07 earnings estimate. We have factored in faster growth in time Financials at a glance (Rs m)
Net sales Sales growth (%) Operating profit Operating profit margin (%) Net profit Net profit margin (%) Balance Sheet Current assets Net fixed assets Investments Total Assets Current liabilities Net worth Total debt Total liabilities 5,328 1,774 276 7,378 1,992 1,318 4,067 7,378 5,124 1,818 276 7,218 1,830 1,604 3,783 7,218 FY04 8,949 21.3% 1,056 11.8% 112 1.2% FY05E 10,980 22.7% 1,110 10.1% 373 3.4%

product division revenues, as the precision engineering initiative is likely to gain pace. We have factored in around 20% CAGR in jewellery division revenues in the same period. As far as our margins estimate are concerned, we have increased EBIT margins by around 40 to 50 basis points each year, in line with the change in product mix and better capacity utilisation. We had initially recommended the stock at Rs 67 in July 2003 with a target price of Rs 120 over the medium-term. We then recommended a HOLD at Rs 120 in February 2004 with an upgraded earnings and target price of Rs 175. Keeping in mind the scope for balance sheet restructuring and visibility in earnings, we re-iterate a BUY on the stock with a target price of Rs 250 over a two to three year investment horizon. Having said that, investors should note that the risk profile of the stock is high. Valuation table FY04
Revenue (Rs m) PAT (Rs m) EPS (Rs) P/E (x) M. Cap/Sales (x) 8,949 112 2.6 65.6 0.8

FY05E FY06E
10,980 373 8.6 20.1 0.7 13,213 604 14.0 12.4 0.6

FY07E
15,735 781 18.0 9.6 0.5

FY06E 13,213 20.3% 1,357 10.3% 604 4.6%

FY07E 15,735 19.1% 1,603 10.2% 781 5.0%

5,445 1,862 276 7,583 1,878 2,100 3,605 7,583

6,004 1,906 276 8,186 2,070 2,730 3,386 8,186

Titan Industries Limited

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29 January, 2005

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Titan Industries Limited

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