Titan: Valuation too expensive, it's time to move on

If you’re an investor holding Titan stocks in your portfolio, perhaps it’s time to “move on.”

On Tuesday, brokerage Citi initiated coverage on Titan with a “sell” rating, defying consensus with a target price of Rs 190. The primary reason for the brokerage’s contrarian view is the stock’s valuations. According to Citi estimates, the stock is trading at 27 times its 1-year forward earnings, which, the brokerage says, is very expensive.

The stock has also outperformed the market: while the Sensex tanked by 20 percent in the past 12 months, Titan has only slipped by 2 percent.Given these hearty gains and steep valuations, there’s little room for a re-rating or meaningful upside.

In addition, Titan’s management does not expect any “extraordinary” performance from the company, which also adds to the argument that the stock is unlikely to soar significantly from these levels.

Bhaskar Bhat, managing director, Titan, in an interview to CNBC TV 18, said the jewellery segment could see growth in excess of 35 percent (by value), although in terms of unit sales, growth could be more muted at 8-10 percent for the year ending March 2012. Further, he added, all three businesses are still projecting 30 percent growth in revenues to Rs 8,000 crore, although net profit levels have not seen any change.

Add to that the weakening rupee and the gold price movement (the company has sizeable imports from both China and Switzerland). With the rupee weakening to all-time lows, margins are likely to take a severe hit.

With regard to gold, the Citi report noted that there is a very strong co-relation between the price of gold and the performance of Titan’s shares. The jewellery business is the key driver of Titan’s overall profitability, contributing 77 percent of Titan’s revenues and 69 percent of operating profits in the year ended March 2011. The correlation between gold prices and stock price could, however, diminish as diamond jewellery sales increase and other segments, like eyewear, gain better traction.

While the company is adequately hedged against gold price volatility, jewellery-making charges are linked to the gold price. So, margins could come down if gold prices fall.

Operating margins have also expanded by 2 percent over the past two years. Now that costs are rising and the management is trying to spur demand through attractive discounts, margins will be range-bound and could even fall in the next 24 months.

According to Citi, Titan’s stock is trading at 25 times its estimated earnings per share for the 12 months to March 2012. That valuation is the average valuation for the stock in the past five years.

By that measure, the stock’s target price is calculated at Rs 190 by the brokerage. Interestingly, the stock fell 5 percent to Rs 188, within hours of the release of the report. Regardless of that fact, the point of view remains. Even if you decide to hold on to the stock, do not expect great returns.

Watch video:Time trouble? Titan says no ’extraordinary’ growth on cards