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The Curious Case Of Gitanjali

Gitanjali Gems was trading at Rs. 520 on 21st June, 2013 and after a series of 5% down circuits it is now at Rs. 70. To all people who have access to the Indian stock markets, this might be a great Investment opportunity.

There have been a lot of stories floating in the market about Gitanjali along with news of some likely fraud by LIC. However, all of these stories have nothing to do with what seems to have actually happened. Here is my take on the entire Gitanjali saga and a valuation of the company.

In order to curb the rising current account deficit the government of India increased duties on non essential imports and Gold was on the top list. Import duty went up from 2% to 10% in two months and the RBI made it difficult for financing gold imports. The second part of the statement is more important that the first one.

How did the RBI make the financing for gold imports more difficult? Earlier a jeweler could import gold in bulk by placing only 20% of the money upfront as margin. However, in a directive in June the Reserve Bank of India banned this practice and forced all parties to place 100% of the money upfront. Every importer was hit in this move, one more than the other. However, Gitanjali's stock price took the hardest beating. Why?

The promoters of Gitanjali had pledged their shares as a guarantee against their payments. However, when the RBI suddenly increased the margin amount, it was obvious that the company would not be able to come up with so much cash in such a short duration of time. So the pledge got invoked and the banks started selling the shares in the open market to recover their money. This lead to a series of down circuits which have brought the stock down to Rs. 70.

Now comes the Valuation part:

Here we have a bunch of hypothesis on which we base our valuation.

1. Indian's appetite for gold is never ending, and once the cost of gold comes down their buying of gold will resume.

2. The move by the government is only temporary and over a 1-3 year time frame we see the import duties getting back to normal (2-4% from the current 10%).

Point to be noted is that the RBI directive to place 100% margins has been quashed and a new directive was issued a few days earlier saying that 20% of the gold has to be compulsorily exported. Since Gitanjali is India's largest jewellery chain, I don't see this as a problem as the company has many well known brands under its offering.

Below is a simple valuation that I have done:

 

 

Particulars

Quarter ended (in Lacs)

 

30.06.2013

31.03.2013

31.12.2012

30.09.2012

30.06.2012

March 31, 2012

December 31, 2011

 

Q1-FY 2014

Q4 - FY 2013

Q3 - FY 2012

Q2 - FY2012

Q1 - FY2012

Q4 - FY 2011

Q3 - FY 2011

Net Sales / income from Operations

391,918.43

475,053.14

435,497.98

392,825.10

338,473.41

353,204.57

341,786.68

Total Shares issued by the company

92,068,172.52

92,064,534.02

92,071,646.34

92,071,646.34

91,120,764.19

91,120,071.32

91,119,798.42

Sales per Share

425.68

516.00

473.00

426.65

371.46

387.63

375.10

Price per share as of last day of quarter

233.90

592.00

530.00

348.00

300.00

324.00

301.00

Market Price per share / Sales per share

0.549470

1.147286

1.120510

0.815654

0.807633

0.835858

0.802461

Quarter on Quarter the sales have definitely taken a hit because the price of gold has increased by Rs. 3200 only due to the increase in the import duty from 2% to 10%. Due to the disruptions in the market the working capital cost has also increased which has lead to a hit in the net profit margins for the company. However, stating all of this is not rocket science, this is just obvious.

Here is where the fun lies.
I calculate the total number of shares issued by the company and divide the total sales by total number of shares. This gives us the 'Sales per Share' figure. Then I take the price per share as of the last day of the quarter and divide this by the sales per share figure. This gives us the Market price to sales ratio. In simple English this means the price I must pay to get Rs. 1 of sales of the company. The figure for the last few quarters has been calculated in the table above. This number has been around 0.8 after which it increased to 1.1 for a few quarters. As of August 15th, the price of the stock is Rs. 70 and if we assume that the company will generate similar sales as per the last quarter then we get a market price to sales ratio of 0.1647.

Ratios like the price to sales ratio generally remain fairly constant because this is what the market awards to the company. Hence there will most likely be a reversion to the mean unless there are events that call for a new mean. Under this assumption it would be fair to expect the ratio to climb back to 0.8 in the next year or two. If this were to be the case then the price for the stock should be Rs. 340. Even if the ratio were to climb to 0.5 the price would be as much as 212. That is a manifold gain from the current levels.

This stock is currently experiencing unprecedented volatility and is like a falling knife and the best idea would be staggered buying or waiting till all the volatility has died down. The ideal strategy would be to buy only 5% of what you want to buy every week.

Will post more on this as I get time.