Gold price continues to shine - Will custom duty hike force jewelry-giant Titan to shock clients by raising rates?

Gold price continues to rise in various parts of India, especially in metro cities. A lot has changed in the past three months for gold and other metals. Few obvious factors were hopes of US Federal Reserves rate cut, geopolitical tensions, bearish mode on stock exchanges and trade war which made investors to park their money in safe haven assets like gold. But things turned ugly for a dominator in the gems & jewelry business in India! This would be Titan Company, which currently,  rules not only many Indian hearts when it comes to buying gold, but is also a highly valued stock for investors on Dalal Street compared to peers. Titan is unique compared to rivals which makes it a favorite. But Titan is now in a dilemma as gold price keep rising and may do so going forward. This is the result of gold custom duty hike in Union Budget 2019. 

The impact of custom duty hike! 

Gold prices have been soaring to new heights due to global factors. However, things changed for Titan when Finance Minister Nirmala Sitharaman announced a custom duty hike in gold and other precious metals to 12.5% from previous 10% on July 05, 2019, in her Budget 2019 speech. Negative impact was immediately witnessed in Titan shares. 

A day before Budget 2019 announcement, meaning July 04, 2019, Titan shares were trading near Rs 1,290-levels, but immediately tumbled post announcement. Now nearly three weeks have passed and Titan from that level is struggling even to retain near Rs 1,090-levels. On Wednesday, Titan shares touched an intraday low of Rs 1,081.40 per piece on Sensex. Now that would be a drop of a little over 16% in nearly 3 weeks of July 2019. At around 1428 hours, Titan share price was trading at Rs 1,089.40 per piece down by 0.96% on Sensex. 

The real question is - how seriously has the custom duty hike on gold impacted Titan. And, will the company be forced to hike its gold and jewelry prices ahead. The latter is most likely the case, as when custom duty is hiked it forces almost every jewelers to pass on the tax burden on their end prices to customers. This could also impact Titan’s earnings. Hence, investors have become cautious in Titan shares. 

Can really custom duty hike impact Titan?

Notably, it is known that, Titan sources ~40% of its gold from customer purchases (via exchange) and ~60% via metal gold loans. Nillai Shah, Equity Analysts along with Research Associate namely Indira Badrinarayan and Archana Menon at Morgan Stanley together stated that,  in our view the budget proposal is a sentiment and business negative for the jewellery industry. Here’s how, as per the trio. 

Firstly, the hike in custom duty comes at a time when the gold price in local currency is up ~10% in the past 2 months, and now would further increase the price of gold. The trio said, “In the past we have observed that a sharp increase in gold pricing leads to consumers postponing purchase decisions.”

Secondly, if customers do begin considering the higher tax component in the local price of gold, such would lead to nightmare for jewelry makers as demand would be impacted. Especially if the customers are those who buy jewelry as a store value than to just wear them. 

Another shocking impact would be and is feared by many experts is that, custom duty hike may give rise to grey market such as rise in smuggling of gold to evade both customs duty and GST.

Additionally, increase in income tax for high income individuals may impact high ticket discretionary consumption demand.

Thus on Titan, the trio said, “Titan stock is up 42% in the past six months (vs. +9% for the Sensex), making it the best performing stock in our coverage. Its 12-month forward P/E at 53x is at peak level in the last decade and at a 25% premium to its five-year average. After the stock's run-up, re-rating is complete, in our view. Balanced risk-reward prompts us to take a breather and await a better entry point.”

They added, “We are not calling for downside to numbers – quite the contrary, our F20 earnings estimate is ~4% above consensus. Even as long-term holders may continue to do well with Titan stock over time, we see less room for positive surprises in coming quarters.”

Even Kotak Institutional Equities in their note said, “Increase in duty may encourage smuggling. Further, increase in gold price could impact demand in the short term. Modest negative impact for Titan.”

On the other hand, Emkay in its research note said, “We do not expect any impact on Titan as higher customs duty is passed on to consumers.”

Meanwhile, JM Financial’s research note says, “Customs duty on gold imports has been surprisingly hiked from 10% to 12.5%, which is in complete contrast to the industry’s expectation of a partial rate roll-back to help counter illegal gold imports. The additional levy would be passed through by jewellers to consumers and could impact demand in the very short-run till consumers get used to the higher price-level. This move could, however, further encourage illegal imports and tilt the scale in favour of non-compliant players.”

Overall, Titan is unlikely to  escape from the rising gold prices dilemma. 

On Wednesday, gold price in major metro cities rose drastically. A 10 gram in 22 karat gold was available at Rs 33,340 up by Rs 230 in Chennai, Rs 34,050 up by Rs 50 in Delhi, Rs 34,490 above Rs 160 in Kolkata and finally Mumbai where prices were at Rs 34,350 higher by Rs 350. 

As for a 10 gram in 24 karat, was priced at Rs 35,350 in Mumbai, Rs 35,690 in Kolkata, Rs 35,250 in Delhi and Rs 36,530 in Chennai. Prices here rose by Rs 50 to Rs 350.