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February 28, 2012

Diamonds are Forever as Demand Outpaces Supply in Emerging Asia

Diamond
Analyst Insight by Rob Walker

Graff Diamonds Ltd, the London-based jeweller renowned for buying and selling some of the world's rarest and most expensive rocks, aims to raise around US$1 billion from a planned Hong Kong IPO in the second quarter of 2012. What will it do with the capital and what does the listing tell us about the strategic direction of the diamond industry?

Graff goes east to tap into new era of growth

Graff was founded 52 years ago in London and has a client base that includes some of the wealthiest people on the planet. However, as a privately-held firm it is finding the competitive operating environment for growth increasingly tough. LVMH and Richemont, among its rivals, are publicly traded and each has the economy of scale to respond quicker to new retail opportunities in what has become a rapidly evolving global luxury jewellery market.

In particular, inventory and real estate rental costs at the luxury end of jewellery are exorbitantly high, and despite Graff's robust financial fundamentals it is behind the curve when it comes to its ability to finance new expansion opportunities. For example, it lacks the financial capacity to significantly improve its visibility in many of the world's most coveted retail locations.

An initial public offering (IPO) is the speediest route to bulking out Graff's financial muscle, and Hong Kong's stock market make sense (even though its performance has been lacklustre this year), firstly because it is a hub for Asian investors with a keen eye on the luxury goods market and, secondly, because it acts as a fast-track corridor into the booming luxury goods demand of China and emerging Asia. Prada similarly chose Hong Kong over Milan, New York or London for its US$2 billion IPO last year.

Diamonds generating stronger investor interest as an alternative asset class

Globally, Graff operates 34 outlets, which are divided evenly between the US, Western Europe and Asia. But, China is Graff's fastest growing market. Last year, the company's Asian sales registered triple-digit growth, according to company sources, with China leading the surge. This is indicative of trends within the industry as a whole as China's new generation of ultra high net worth individuals (UHNWIs) seek to satisfy an insatiable appetite for luxury consumption.

In 2010, retail sales of luxury jewellery and timepieces in China summed around US$3 billion, compared with US$11.5 billion in the US, according to data from Euromonitor International. That disparity will narrow markedly over the next 10 years. Indeed, demand for diamonds in China is currently growing faster than the available supply of rough stones.

According to industry sources, growth in demand for diamonds is running at around 6% globally, with China driving the trend. Yet, growth of supply is running at around 3%. Whenever there is such a differential between supply and demand there is only one way for prices to go, and that is up. And as the gap between supply and demand widens over the medium to long term, which is the industry consensus, so prices will increase substantially.

It is little surprise that - much like fine wine, fine art and classic cars - investors are increasingly viewing diamonds as an attractive alternative asset class. This is particularly evident with Asian investors, who already have a heritage of buying gold. All of which bodes well for Graff's planned IPO, which has potential to raise some US$1 billion.

Graff IPO will bolster its position in China and across emerging Asia

Graff will use the capital from an IPO first to open new outlets in prized retail locations in China and emerging Asia and, secondly, to shore up its inventory to feed the growing hunger of cash-rich Asian consumers. Over the short term, it will open new stores in Wynn Macau, Hangzhou (mainland China) and a second outlet in Hong Kong. By 2020, Chinese consumers could account for as much as a fifth of the world's total diamond demand, compared with less than a tenth today.

It is probable that Graff will also look to build new retail positions in India, which alongside China has been identified as the fastest growing market in the world for luxury jewellery over the next five years. Compound annual growth in luxury jewellery and timepieces in India is forecast at 26% to 2015, compared with 2% in the US, according to Euromonitor International.

Graff's Hong Kong IPO will mark a critical shift in the global diamond industry. Much like Prada's decision to instigate a Hong Kong IPO in 2011, it is evidence of a seemingly unstoppable easterly tipping point in luxury goods consumption culture. In both cases, the added value of a Hong Kong listing is that Asian investors have their eyes and ears close to the ground in terms of Chinese consumption trends, and are more in touch than most with the luxury goods boom and its ongoing growth potential.

By boosting Graff's financial power, the IPO could also hasten the arrival of a new super league of luxury jewellery players. Such is the pool of cash needed to support inventory and real estate needs that smaller scale jewellers could start to drop out of the marketplace over the medium to long term. And as the industry becomes more consolidated, financial clout will become ever more critical to driving market share. 

 


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