Not All That Glitters Is Gold

Financial analysis of Indian Jewellery company

Do You Have Ticking Time-Bombs in Your Portfolio?

The company covered in this post is amongst India’s large integrated diamond and jewellery companies. In early 2013 when company’s stock price was soaring to new highs, Multi-Act’s analysis of the company unearthed serious issues raising questions over quality of company and its management.

Stock price performance from 2006 to 2012:
stock price performance of Indian jewelry company

About the Company:

The concerned company operates in two segments: diamonds and jewellery.

  • The diamond segment’s operations involve sourcing rough diamonds from international markets followed by the cutting and polishing of those rough diamonds for resale in the domestic and export markets.
  • The operations of the jewellery segment involve the manufacturing and selling of both branded and unbranded jewellery in the domestic and export markets.

The Market View around 2012-2013:

Due to increasing consumer discretionary spending, the market expected a shift towards branded jewellery and higher revenue growth for companies operating in that space. The company studied was originally heavily in diamond business which had thin margins but was slowly increasing its footprint in the jewellery sector, which had relatively higher margins.

a. Shift of business from Diamonds to JewelleryJewelry & Diamonds sales mix for Indian jewelry company

b. Margins in jewellery business being better than that in diamonds.Comparison of Margins for Indian Jewelry companyThis shift of the company to a higher profit margin business at the opportune time of increasing consumer spending made the markets view this company favorably. However, Multi-Act’s analysis unearthed serious issues regarding the company’s Quality of Earnings and its Corporate Governance.

Summary of Multi-Act Analysis

  • Grade: B-, Poor quality company
  • Issues
    • High debt, low interest coverage, negative OCF coverage for debt.
    • Corporate Governance and QoE issues
    • Pledged shares

Soon thereafter, the stock faced a 90% tumble from around 600 to around 70-80, and has not regained its former high price even after 5 years.

Stock price from 1st January 2013 to 19 February 2018Stock price chart for Indian Jewellery Company

Indicators of Poor Quality of Earnings and Corporate Governance:

1. DuPont Analysis

The DuPont analysis technique breaks down the Return on Equity (RoE) into different parts, helping the analyst to judge the source of the ROE.

In common terms, DuPont analysis tells us that

Return on Equity = Profit Margin x Asset Turnover x Leverage

While analysing this company, we observed that even though its ROE was apparently moderate, its source was neither healthy nor sustainable. The ROE was derived as

Moderate ROE = Low Margins x Average Asset Turnover x High Leverage

The high leverage (even after frequent equity issuance) was boosting the thin margins to generate moderate RoE.Dupont analysis for Indian jwellery company2. Low Interest Coverage

In spite of the shift to higher margin Jewellery business, the company had very thin profit margins. To add to their woes, large part of the profits were outgoing in the form of interest. After paying interest, it had limited profits available for shareholders.Comparison chart of Operating profit vs. Interest cost3. Cash Generation

Cash generation is essential for survival of any business. Inability to generate cash for a long period of time is a key concern for Quality of Earnings. A company having sufficient operating cash flows can sustain its business using internally generated money, otherwise it has to constantly raise money by debt or equity. Assessment of the concerned company’s cash flows depicted bleaker picture than the one shown by reported earnings.

A. Over a decade (from 2001 to 2012), the company had failed to generate any operating cash flow.

Cumulative – 2001 to 2012

INR Million

Total reported profits


Cash consumed in working capital


Operating Cash flow


OCF generation over the years had been negative due to large amounts of cash consumed in working capital.  More than 40% of their sales remained uncollected at the end of every year. They also held a large inventory that was probably due the increasing focus on jewellery.  Unfortunately for the company, its vendors were not as generous to it as it was to its customers. The company had to pay its vendors before it could collect money from its customers.Sales and Cash conversion cycle cost

B. In absence of any cash generated by the business, the company’s major sources of finance were new share capital and borrowings.Sources of Funds for Indian Jewelry companyC. Misallocation of Capital:

Despite having a business that consistently swallowed cash, the company continued borrowing/ raising capital to expand, disregarding a basic mathematical principle that

‘Multiplying a negative number by any amount will always result is a bigger negative number.’Application of Funds for Indian Jewelry CompanyIssues in Corporate Governance

  1. 51% of a group company was acquired in 2006 for INR 66 million, and remaining 49% in 2009 at INR 1,632 million. It meant that a related company was revalued upwards by 25 times in only 3 years, with shareholders’ money.
  2. During FY 2007 company deferred expenditure worth 20% of profit before taxes without any disclosure of nature of the expense. Immediately in next year, this deferred revenue expenditure was promptly written off. This is a clear case of an accounting shenanigan, and does not bode well about the accounting transparency of the company.
  3. We observed that in many cases, an increase in gross margin was associated with a drastic rise the inventory and receivables numbers. In our experience, this occurs when management manipulates profits by showing lower costs and higher inventory or sales figures by dubious means of channel stuffing or reporting bogus sales.
  4. There are two quantitative scores that indicate probability of earnings’ manipulation and year on year improvement in fundamentals, viz M score and F score. The company had a record of consistently Poor F Score, and M Score suggested possibility of manipulation in 9 out of 11 years.
  5. As of March 2013 promoters had pledged 35% of the shares owned by them with lenders. These shares were 21% of company’s total outstanding shares. Pledged shares indicate risk of sell off by lenders if prices start declining.

The above Quality of Earnings and Corporate Governance issues made us steer clear of this company irrespective of the market’s exuberance. A timely analysis saved us from this ticking time bomb, and this became a good example of companies to avoid.

Get in touch with us to understand how Multi-Act can save your portfolios from such disastrous investments.

Source of charts:


The views expressed in this article are for educational and reading purpose only. The article is prepared on the basis of publicly available information, internally developed data and from sources believed to be reliable. Due care has been taken to ensure that the facts are accurate and the views are fair. The Company, its associates or any of their respective directors, employees, affiliates or representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such views and consequently are not liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way for decisions taken based on the said article.

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