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FY21-23E likely to be (significant) turnaround years

Kalyan reported an in-line operating performance with higher disruption in its core markets weighing on revenues in 1Q. Share of gold jewelry continued to be high with continued new customer recruits from the unorganized segment. Lower GSS (advance purchase scheme) subscriptions is marginal near-term headwind. We expect Kalyan to focus on store expansion in FY22. BUY; TP Rs95.

We believe mandatory hallmarking (link) will create a level playing field in the Indian Jewellery market, driving further formalisation. It will lead to (1) likely traceability of raw material (gold) leading to potentially higher imports through formal route, (2) material business disruption for informal players in converting their inventory to hallmarked standards (necessity to melt and recreate ornaments), (3) opportunity for design-oriented brands to realise higher brand premium (versus commodity++), (4) higher industry-wide efforts to drive premiumisation (higher share of studded), and (5) consumers may choose to convert ‘old jewellery’ to hallmark-compliant ornament in FY21-23E.

* India business grows 94%. Revenue grew by 94% to Rs12.7bn; SSSG: 68% (ex GSS; while the base period is not strictly comparable but South India grew by 73% while non-south grew by 170%; studded share declined to 20% from 22% in Q4FY21. The studded ratio continued to remain low with the company gaining new consumers from the unorganised segment particularly for the plain gold jewellery.

For Q1FY22, some of the Kalyan’s core markets (like Kerala, Tamil Nadu) were more disrupted due to higher operating restrictions. The share of south revenue was at 70% compared to 69% in Q4FY21. Other key highlights: (1) Gold coin sales were at ~Rs400mn, 3% of revenues and (2) Currently, most of the stores are open with some restrictions on weekends.

Gross margin (standalone) declined 30bps QoQ to 14.4% due to higher south revenue (QoQ), lower studded ratio and one-time loss due to customs duty cut. Gross margin weakness weighed on EBITDA margins (3.9%). It reported a loss of Rs564mn at the PBT level. Total number of stores were 116 in India. Kalyan’s ecommerce segment, Candere, also saw some pickup – revenue up to Rs240mn in Q1FY22 versus Rs50mn in Q1FY21. The operations continued to be positive at the PAT level.

* Middle East operations hurt by store closures. Revenue grew by 183% YoY to Rs3.4bn (58% of Q1FY20 revenues) despite Kalyan closing 7 showrooms in FY21. On a sequential basis, gross margins expanded 80bps to 18.1%.

* Store expansion to resume. We like Kalyan’s thrust on store expansion. Prior to Covid, the company added 60 new stores in the preceding five years. It is expected to launch 20+ stores in FY22 and 15 stores in FY23. It has already opened nine stores in April 2021. It's other key strengths are (1) hyperlocal model, (2) a network of 750+ My Kalyan centres to drive footfalls and (3) consistent brand investments. Going forward, margin expansion to be driven by (1) expansion in non-south markets to drive gross margin expansion given higher studded share in these markets and (2) operating leverage benefit.

* Valuation and risks: We cut our earnings estimate by 1-3% for FY22-FY23E. We model revenue and EBITDA CAGRs of 21% and 35% over FY21-FY23E. Maintain BUY with an unchanged target price of Rs95. Key risks: delay in showroom expansion and potentially higher competitive intensity in core South India markets.

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