Over the last decade in my investing career, I have seen several small and mid cap companies with credible capital allocation but rarely i have been so awestruck with the capital allocation policy of a company. While tech companies who make significant cash profits and require minimal incremental capital for further growth exist (majorly in US and some in India), rarely have i seen such companies in non-tech space. I have read a lot about incremental cash being used for buybacks to make better use of capital by companies like Apple rarely have i seen that happen here in India until i came across such an interesting story – Goldiam International Ltd.

Background & Metamorphosis

Goldiam International Ltd was incorporated in 1986 and deals in export of fine natural diamond studded jewellery, lab-grown diamonds and lab-grown diamond studded jewellery. The company has three manufacturing plants in SEEPZ (SEZ in Andheri, Mumbai). The company was founded by Late Mr. Manhar Bhansali and is currently managed by his Son Mr. Rashesh Bhansali (Chairman) and his grandson Mr. Anmol Bhansali (Whole Time Director). Mr. Rashesh Bhansali has been involved in the family business for the last 28 years and has vast experience in the field of Diamonds and Jewellery. Mr. Anmol Bhansali is a graduate from Wharton School (University of Pennsylvania) and has also acquired GEM130 and GEM230 certifications, constituting two thirds of ‘Diamonds and Diamond Grading’ course, from Gemology Institute of America 2017. He has been in the business for the last 6 years.

Lets take a look at the evolution of Goldiam International Ltd over the last few decades in 4 stages as follows:

Stage 1: Building the Foundation

Goldiam International Ltd (Goldiam) was incorporated in 1986 by Late Mr. Manhar Bhansali and operations majorly comprised cutting and polishing of diamonds for the first few years until ~1995. Cutting and polishing of diamonds was/is a pure commodity business with high volumes and extremely thin margins (2-3%). At this stage the business requires low capital and the inventory turns are generally high as there is no element of innovation or designing here. While the element of cyclicality is high as low margins makes the business vulnerable to extreme volatility in prices (although Diamonds prices are far more stable vs Gold) the high competitive intensity makes it even tougher as there is barely much to differentiate from the competition. However, the base operations helped the company build a decent capital base to take the business to the next stage.

Stage 2: Distribution of Gold and Diamond Studded Jewellery via Wholesalers

Post 1995, the company shifted focus on value addition and started production of diamond studded jewellery and Gold Jewellery. Operations mainly involved supply to wholesalers in USA (through Goldiam USA Inc.), Domestic market (through Diagold Design Ltd) and a couple of other joint ventures in Malaysia, Hong Kong etc. Wholesale operations mainly involved credit for 3-6 months while margins were in the range of 8-9%. During this phase the next-gen of the promoter family took charge – Late Mr Manhar Bhansali’s son Rashesh Bhansali – who drove the focus on value addition and distribution via wholesaling across the world. While margins improved during this phase RoCE remained depressed due to the high working capital requirement of the business model and did lead to negative economic value creation for the business (RoCE<cost of capital). But this stage did help the company in developing better understanding of retailers in US and India. At the later end of the stage the company also realised the drag on returns due to operations in India and Hong Kong.

Stage 3: Moving down the value chain shifting distribution channel from distributor to retailers

Starting 2016, the next-gen of the promoter family – Mr. Anmol Bhansali – entered business. While there is limited availability of knowledge in public domain, in my opinion he must have been the prime catalyst in the changes as the company started pivoting again and took a lot of tough steps which delivered amazing results. Lets take a look at some of the key steps:

1. Started focusing on supplying directly to top retailers in US causing the change in channel mix. As of FY21 retailers contribute to 80% of the topline of the company (vs. 100% supply to wholesalers until FY2015). This changed the margin profile of the company permanently as evident from gross profit margins – moved from 19% in FY15 to 33% in FY21. Supplying to retailers directly comes with its own set of associated costs in the form of establishing relationships with retailers by itself and managing a sales team for the same, however the benefits over long term far outweigh the costs.

2. Took steps to wind down operations of the wholesale business in Hong Kong and India which led to release of capital yielding low returns. Both businesses involved majorly supplying jewellery to wholesalers which had the long credit cycle (~4-6 months) and low margins. In 2020, the company wind down the operations at the gold jewellery plant in Mumbai for domestic market and also sold the plant (profit realized in FY21). This further decreased the share of low margin business while improving the working capital cycle significantly – 207 days in FY15 to 119 days in FY21. All these corporate actions now makes the company a purely export focused player where minimal margins are 18-20% (at EBITDA level on an annualized basis).

3. Bought a 88% stake (in two stages – 51% in Dec 2020 and further 37% in June 21; remaining 12% owned by technology partners) in Eco-Friendly Diamonds LLP (earlier was promoter owned) which is engaged in the manufacturing of lab-grown diamonds which further improves the margin profile as the margins range from 30-35% here. Having presence in lab-grown diamond manufacturing further helps the parent company secure its sourcing of diamonds to stud jewellery with. This makes Goldiam the only large integrated exporter of lab-grown diamond studded jewellery. This moves comes at a very opportune time as the trend around lab grown diamonds has picked up significantly in the last few years (more on this later). Currently, Lab-grown diamonds and related jewellery account for 10-15% of the business and the share of the same is expect to increase further. Company has already announced capex of 15cr (asset turns of 1.5x) and will keep on doing further capex, calibrating it with the demand scenario.

4. The US jewellery market comprises of large organised players, accounting for nearly 60% of the market, the rest of the market comprises of Independent Mom & Pop jewellery stores. While the penetration across large retailers is quite good for Goldiam, it has limited presence across Independent jewellers. To address this market, the company has recently commissioned an e-commerce portal called JewelFleet . This portal will let small jewellers order existing/custom designs (1000+ SKU’s) which will be manufactured and shipped within 7 days to the jeweller. This business would be a negative working capital business for the company as the raw material is procured on credit for 2-4 months while the receivables here would be almost immediate and the inventory would be manufactured and shipped post order. Also, margins shall also be better than average due to better bargaining power due to lower order size (vs. large retailers) combined with the convenience of just-in-time. The initial response is good but JewelFleet accounts for only 1% of the business yet and it will be interesting to see how the story unfolds here.

5. In the last few years, Goldiam has also scaled up its dot com business, which now contributes almost 20% of topline. In this business the company caters to orders received via e-commerce portals of large retailers. These orders are directly shipped to end client by Goldiam, reducing the lead time for the retailer and also helping them to optimise their inventory. Here too, the just-in-time nature of the transaction along with the handling of shipments helps yield better margins versus bulk supply to physical stores. This again is a negative working capital business as the payment terms are better than supply to physical stores.

6. Goldiam has done 3 buybacks over the last 5 years – with the last one being in December 2021 at Rs 1200 (total 45.6cr buyback) resulting in reduction in equity base of close to 9.3% which will lead to higher EPS and RoE for retaining shareholders.

Stage 4: Way Forward

With the stage set for growth now it is going to be interesting to see how the story unfolds. In the last 5 years a lot has already changed for the business which may not be evident in the topline (~4.5% CAGR FY16-21 – mainly on discontinuance of wholesale business in India and HK led to reduction in sales) but the bottomline has improved decently (13.4 CAGR over FY16-21). Going forward, i mainly see the share of lab-grown diamonds and lab-grown diamond jewellery improving further (guess maybe to 30-35% of topline in 4-5 years) while JewelFleet is difficult to even guess (but sharp scale up here would change how financials look significantly). So in a nutshell expecting further margin improvement and in effect RoCE improvement. While wider adoption of lab-grown diamonds may reduce the cost of diamonds further (earlier lab-grown used to be at 50-60% of the cost of diamonds to now at 30-40%) it will surely increase its volumes (in terms of caratage). So taking further control of the entire value chain to protect/improve margins may make a lot of sense. Company has always been cash positive (200+cr cash & investments – majorly parked in debt funds) which is a rare to find in the Indian diamond & jewellery industry. With so many past cases of value destruction (Gitanjali Gems, Winsome Diamonds, Nirav Modi etc.), mainly due to higher debt (may lead to inflated inventory & debtors), a company with net cash position provides significant comfort. Although the company does use debt occasionally to take advantages of lower raw material prices or to procure inventory ahead of key season (October-December usually strongest due to Thanksgiving and Christmas) the debt/equity is barely 0.1-.0.2. Further, declining inventory and receivables (in terms of days outstanding) along with increasing sales is a good sign, stock buybacks legitimizes the cash position of the company. It remains to be seen how the company uses this cash position for further value creation (further buybacks or maybe other value accretive corporate action).

Why Lab-Grown Diamonds?

Lab grown diamonds share the same physical and chemical properties as natural diamonds. Lab grown diamonds are real diamonds that last forever but are an estimated 30-60% less expensive than mined diamonds. There are two ways Lab-grown diamonds are made – HPHT (High Pressure, High Temperature) and CVD (Chemical Vapour Deposition).

In HPHT, the goal is to replicate the process of how a natural diamond is created below the surface of Earth by creating an environment of high pressure and high temperature where diamond growth can occur (pressure over 1.5 million pounds per square inch and temperature above 1400 °C). Each process starts with a seed of a diamond material (mostly manmade) which is placed in carbon, the element all diamonds are made of and put under extremely high pressure and temperature. In these conditions, carbon melts and forms into a diamond around the seed.

While in CVD a thin wafer of a diamond crystal is placed in a vacuum chamber and heated to 800 °C. Then the chamber is filled with a carbon-rich gas, such as methane, and get ionized into plasma using lasers, microwaves or others. The ionization breaks the molecular bonds in the gas, and pure carbon gets deposited on the wafer of a diamond crystal, growing a gemstone atom by atom, layer by layer.

The difference between the two is HPHT requires higher temperature and mainly produces yellowish and brownish yellowish diamonds. Also, given the importance around climate change, CVD is clearly a better choice as it consumes less power and is cost effective. Even Goldiam produces lab-grown diamonds using CVD. Majority of HPHT producers are based in China.

Initially, the acceptance of lab-grown diamonds was low as large diamond miners of the world opposed it. But in 2018, in a ruling by the Federal Trade Commission in US, lab-grown diamonds earned the status of being called diamonds, making them officially optically, physically and chemically equivalent to natural diamonds, however to make it easier to distinguish between the two and avoid deceptive advertisement – the origin of diamond had to be mentioned (why they are termed Lab-grown diamonds). Post the ruling the number of retailers stocking lab grown diamonds jewellery shot up significantly (~10% 5 years ago to 66% now – amongst Major retailers). There are several advantages of lab-grown diamonds – Environmentally friendly, Affordability (~30-40% of natural diamond now) and No conflict (human rights violation). While being environmentally friendly may not be the key selling point as the energy used to produce them may or may not be sustainable, the key selling point – primarily important to millenials – is affordability (can get higher caratage for the same budget) and most importantly there is no conflict in terms of human rights violations (Blood Diamond). Lastly, the introduction of lab-grown diamonds has sort of expanded the diamond jewellery market as now retailers are able to sell larger caratage jewellery (earrings, necklace and bracelets) which were earlier considered price prohibitive (too expensive). Although there might be some cannibalization of sales, markets for both lab-grown and naturally mined would operate side-by-side and continue to grow, however, lab-grown is expected to grow faster.

Even De Beers (the world’s largest diamond mining company) launched its own line of lab-grown diamonds – Lightbox – in anticipation of the disruption in the industry. Another global retailer – Pandora announced its plans to move from naturally mined to lab-grown diamonds. While the biggest retailer in US – Signet – has also started offering the same.

“As a consumer-inspired company, we offer both natural and lab created diamonds to our new and loyal customers at Signet. We have expanded offerings within our Kay, Zales and Jared locations,” shares Tonia Zehrer, senior vice president and chief merchandising officer.

Signet Jewelers

Competition

Major competitors for Goldiam are private while amongst listed companies Renaissance Global Ltd is a peer. However, it is not a like for like comparison as Renaissance’s business model is different and is focused on branded jewellery (both licensed and own). Also, most of the larger peers also deal in cut & polished diamonds which is a trading business (2-3% margin) which is a category Goldiam has steered clear of. On the lab-grown side major competition comes from China (~25% of world supply and majorly using HPHT) but there are quite a number of units in India (Surat & Mumbai) as well. However, majority of these manufacturers are pure producers of diamonds (cut & polised) of lower caratage (<1) which Goldiam itself procures from the market. It uses its own manufacturing facility for larger caratage diamonds (>1) as they come with higher margins (diamond price’s are not linear i.e price of 2 carat diamond is far higher than double of 1 carat).

Risks

The major risk i see in this business is the cyclicality as it is related to discretionary spending. Retailers like Signet have started taking steps to reduce dependence on big holiday-cycles and move to a always-on approach by spending on marketing and deepening customer engagement. Also, with lab-grown diamonds with lower ticket sizes should reduce the element of cyclicality further, although it might take a while. Its much better to look at the business from an annual perspective as on a quarterly basis too cyclicality plays a big role due to holiday-cycles. The US jewellery market has averaged around 60-65 Bn USD (at retail) and last year has seen dramatic growth (almost 50% to almost 85-90 Bn USD) mostly on the back of stimulus and higher income for discretionary spending (due to lower spends on lockdowns and restrictions on travel & allied activities). The average ticket size of USD400-450USD (higher for lab-grown ~900-1000USD) is not as small as Vaibhav Global’s – ~50-60USD (fashion jewellery), but not too expensive either as US isn’t a market for replacement and people consider jewellery majorly as an accessory.

Financials

P&L Snapshot

Particulars	FY17	FY18	FY19	FY20	FY21
	​	​	​	​	​
Revenue​	321 ​	319 ​	446 ​	365 ​	406 ​
Growth %​	-3%​	-1%​	40%​	-18%​	11%​
EBITDA​	25 ​	25 ​	55 ​	43 ​	78 ​
EBITDA Margin​	8%​	8%​	12%​	12%​	19%​
PAT	28 ​	20 ​	46 ​	45 ​	67 ​
PAT Margin​	9%​	6%​	10%​	12%​	17%​
EPS (Rs)​	11 ​	8 ​	19 ​	20 ​	30 ​
RoCE​	8.0%​	7.6%​	13.4%​	11.7%​	21.0%​
RoE​	6.7%​	5.9%​	13.4%​	11.8%​	14.0%​
Working Capital Days​	179​	197​	134​	132​	119​

Particulars	FY17	FY18	FY19	FY20	FY21
Share Capital​	25​	25​	23​	22​	22​
Reserves & Surplus​	305​	331​	361​	388​	443​
Long Term Borrowings​	0​	0​	0​	0​	0​
Short Term Borrowings​	31​	37​	26​	8​	22​
Trade Payables​	69​	72​	47​	72​	93​
Other Liabilities​	19​	19​	20​	16​	34​
​	​	​	​	​	​
Fixed Assets​	24​	21​	21​	20​	41​
Other Non-Current Assets​	44​	30​	54​	56​	44​
Inventories​	134​	139​	106​	93​	107​
Trade Receivables​	95​	110​	85​	100​	129​
Cash & Equivalents​	13​	29​	64​	55​	92​
Investments​	123​	122​	119​	153​	180​
Other Current Assets​	16​	33​	30​	28​	21​
Total Assets & Liabilities​	448​	484​	478​	505​	614​

Particulars	FY17	FY18	FY19	FY20	FY21
Profit Before Tax​	31​	33​	71​	64​	91​
Non-Cash Expenses​	8​	-2​	-7​	-9​	-6​
Operating Profit Before Working Capital Changes​	39​	31​	64​	55​	85​
Add Working Capital Changes​	-14​	-35​	40​	27​	-10​
Less Tax Paid​	11​	11​	18​	14​	25​
Cash From Operating Activities​	13​	-15​	86​	67​	49​
Capital Expenditure​	-2​	-2​	-2​	-2​	-13​
Cash From Investing Activities​	-17​	-27​	-11​	-24​	-12​
Buy-Back & Dividend​	-8​	-2​	-28​	-32​	-15​
Other Financing Activities​	-19​	6​	-13​	-20​	15​
Cash Flow from Financing Activities​	-27​	4​	-41​	-52​	0​

Special mention again on the capability of the management (especially Mr. Anmol Bhansali) who now seem to have a long term vision and working with immense focus to execute the same. Also, the quality of the board further seems top notch – with presence of Mr. Pannkaj Ghadiali (Chairman of Audit Committee at Balkrishna Industries) and Ms. Nipa Utpal Sheth (Founder of Trust Group).

Finally, this is not a recommendation. Kindly consult your investment advisor before taking any decision.