Indian Gold Retailers Hedge Against Volatility

Companies aggressively expanding to small centers

Indian gold retailers will maintain stable credit risk profiles due to prudent inventory hedging, CRISIL Ratings said. The agency, which questioned 63 gold retailers for its study, found that these hedging strategies have assisted retailers to insulate their margins from volatile gold prices and will help reduce the impact of increased working capital requirements on their financial risk profile.
CRISIL explained that gold retailers are aggressively expanding operations into smaller cities, requiring sizeable investments in gold jewelry for display at their showrooms. The agency warned that debt-funding of such investments will weaken their financial risk profiles, while prevailing high gold prices will inflate retailers’ working capital investments and raise their average costs of inventory.

The ratings agency reported that gold prices have risen by around 20 percent annually during the past five years, through March 2011, and was especially steep in the 12 months through September 2011.

”Any sharp fall by, say, 15 percent to 20 percent in gold prices can impact retailers’ profitability,” Gurpreet Chhatwal, a director at CRISIL Ratings cautioned.

While the impact will be more prominent for retailers with sizeable expansions, and large inventory acquired at high prices, Chhatwal added that most CRISIL-rated retailers are well placed to protect their margins. ”They follow either the inventory replenishment model, or gold-on-loan scheme, or a mix of both, to insulate their inventory against volatility in gold prices,” he explained.

Using the inventory replenishment model, the quantity of gold sold on a given day is replenished that same day to mitigate price risk on the retailers’ gold exposure. The gold-on-loan model gives players the flexibility of up to 180 days to fix prices. This scheme comes in handy for players in expansion mode, who are acquiring inventory for the new showrooms, CRISIL stated.

R. Vasudevan, head of CRISIL Ratings, added that increased borrowings to fund inventory for the new showrooms may dent the retailers’ capital structure. ”Judicious inventory hedging supported by benefits from economies of scale following such expansions will underpin the retailers’ credit quality, over the medium term,” he said.

CRISIL predicted that growth across India’s branded gold jewelry sector is likely to come as new stores are set up in small to mid-size towns. Retailers are expected to generate more than half their revenues from smaller population centers by fiscal year 2012 to 2013, compared with around 40 percent in fiscal period 2009 and 2010.

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