Parul
The coronavirus impact in China coupled with weak demand conditions in key markets is expected to impact the domestic cut and polished diamond industry in a major way. Consequently, ratings agency ICRA has revised CPD industry outlook from stable to negative, in view of the ongoing lockdown in parts of China and Hong Kong (C&HK) region. China accounts for 14 per cent of polished diamond consumption while a larger proportion (35 per cent) of exports from India is currently routed via Hong Kong.
Confirming this, Mr. Jay Sheth, Vice President, Corporate Ratings, ICRA Limited says, “Apart from recent developments in China, the CPD industry had been going through weak demand conditions in key markets and pressure on gross margins due to declining finished prices. If the business lockdown continues in C&HK, industry pressure will aggravate thereby impacting cash flows. This can have a serious bearing, especially given the cautious lending to the sector and; potentially impact CPD players’ credit profile. The pandemic in China will also hit near term global demand for CPD and the widespread economic shutdown in C&HK region which will further delay demand recovery. The industry is already bearing the brunt of on-going USChina trade and political tensions.”
The C&HK region, accounts for 14-15 per cent of global demand for CPDs. China is a major market as it not only consumes imported diamonds locally, but also to produce diamond studded jewellery and export the same to the US, South East Asia and other markets in a big way. The export of polished diamonds to China is largely routed through Hong Kong, which is a major global diamond trading hub alongside Belgium and the United Arab Emirates. Industry estimates C&HK to be currently accounting for 35 per cent of India’s overall CPD exports. This is slightly ahead of the US, the largest market for diamond studded jewellery. Thus, ICRA estimates the domestic industry to be majorly impacted due to its considerable exposure in C&HK.
The challenge has been compounded further as the shutdown has occurred during the busiest period for jewellery sales in China – the peak of the festive Lunar New Year extending from January 25 to February 08, 2020. There has been a complete retail shutdown or slowdown in some of the worst impacted provinces of China; the like to like retail jewellery sales in the region may have declined by as much 70 per cent. The trickle effect is also seen on jewellery manufacturing units because of supply chain disruptions and; factories operating at just 20-30 per cent capacity.
CPD exports are under pressure and down 17.6 per cent Y-o-Y during 9M FY2020 on account of the trade and political tensions and subdued macro-economic environment in markets other than the US. With potential adverse coronavirus impact, exports are likely to remain weak in current fiscal.
The cash flows of CPD companies will be also impacted with the stretch in working capital cycle envisaged on the back of delay in collections and inventory build-up. Most CPD companies avail pre-shipment or post shipment credit (export bills discounting of tenor upto 120-150 days) from banks to fund their working capital requirements. Receivables delay from C&HK region beyond a reasonable time will mean companies will have to make good the payment out of their funds which in turn could pressurize their liquidity position and; thereby problems like distress sales, consequent negative impact on polished diamond prices and lower profitability.
The impact on ICRA’s rated companies portfolio is likely to vary (10 to 45 per cent) depending upon their respective exposure to C&HK. As per information gathered from banks and companies, though the shutdown has been acute since a fortnight, export bill realisations so far have not faced any challenges. The impact on liquidity will become evident as more bills become overdue during second half of current month and next month, provided the amount is significant.
In addition, the slowdown in sales will mean increased finished stock. On the positive side, lockdown in C&HK will also mean more opportunities for Indian CPD companies to cater to diamond studded jewellery demand in the US and other key markets. With Chinese factories operating at low capacity utilisation, such manufacturing can be diverted to India for a short period of time. However, the situation could worsen if the Chinese shutdown sustains for two more months (say until April 2020), Then it could lead to elevated inventory levels for the industry. Exceptions will be companies which have been prudent in their rough diamond procurement; such companies would be able to manage their liquidity better.
Coming to financials, the profitability of CPD players in H1 FY2020 saw a sharp decline on the back of correction in polished diamond prices – the EBITDA margins are estimated to have declined 1-3 per cent in the period. Profitability recovered to some extent during Q3 FY2020 due to greater parity in rough and polished prices and; higher sales. However, sales decline during Q4 FY2020 will result in Y-o-Y decline in profitability. Further, a supply glut in the 30 cents to 1/ 1.5 carat category of polished diamonds meant for C&HK region could lead to a correction in polished prices and consequently lower gross margins.
In recent years, banks’ lending to the gems and jewellery sector has been cautious following corporate governance and related concerns. Restrictions were placed towards sectoral exposure in the light of past and recent defaults and; weak perception over transparency related issues. In this background, the coronavirus related blow shall continue to restrict lending to the sector over next few months.
“Given the aforementioned impacts, ICRA revised the credit outlook on the CPD segment of the Gems and Jewellery industry to ‘negative’. We expect the balance sheet and profitability of the companies to remain under pressure until the threat from coronavirus recedes and business returns to normalcy,” concluded Mr. Sheth.
