Diamond polishing industry caught between lab grown rocks and economic slowdown

• Revenues of India’s diamond industry set to fall 30-35% in FY24 as economic slowdown in three key markets hurt exports.
• While high inventory of diamonds will impair profitability, lower borrowings and debt by polishers will lower risk.
• Industry in a bind as demand slows and supply of roughs also gets impacted due to geopolitical tensions in Russia and West Asia.
  

Diamond polishing industry is headed for turbulent times as revenues are expected to drop 30-35% year-on-year to $14-15 billion in the fiscal year 2023-24, thanks to demand slowdown as economic slowdown deepens in the industry’s main markets — the US, the European Union (EU) and China. Forecast by Crisil Ratings is based on analysis as the three geographies account for nearly 75% of India’s polished diamond exports (US accounts for 35% of exports, China 30% and the EU around 10%).

High inventory of polished diamonds amid falling retail prices will impair profitability of polishers. The silver lining is that a shrinking business translates to reduced debt, which will offer some offset against the pressure on credit risk profiles of diamond polishers. A study of 46 of them rated by CRISIL Ratings, accounting for over a fifth of the ₹180,000 crore industry by revenues last fiscal, indicates as much.

Demand for polished diamonds had started weakening since last fiscal amid slowing economic activity leading to a volumetric drop of ~25%. But worries about supply of rough diamonds following western sanctions on Russian mining major Alrosa supported prices. Polished diamond prices on average were up nearly 10% last fiscal on-year. This helped arrest the decline in India’s polished diamonds exports to $22 billion last fiscal from $24.2 billion in fiscal 2022.

It is not just about weaker demand, even the supply of roughs has been impacted due to disruption. Consequently, prices of roughs have corrected, leading to polished diamonds getting cheaper by 10-15%.

Woes of the diamond industry are not merely related to supply and demand. They also have to do with a new challenger – lab-grown diamonds (LGDs). These diamonds have more than doubled their market share to ~15% compared to last year, despite prices halving. LGDs are 20-40% cheaper than natural diamonds yet have quite similar characteristics, which poses a real threat to the natural stones, says Crisil.

Says Rahul Guha, Director, CRISIL Ratings, “Israel imports ~$1.25 billion worth of polished diamonds annually from India. With the country now declaring a war on the Palestinian militant group Hamas, this number could be at risk. To be sure, there is some bump-up in demand in the second half of every fiscal year from festivities such as Thanksgiving, Christmas and the Chinese New Year, but this is unlikely to provide a significant offset. Consequently, we see the Indian diamond industry shrinking by over a third on an annualised basis this fiscal.”

With the inventory of higher-cost polished diamonds piling up to over 4 months of sales, profitability of polishers will be chiselled 50-100 basis points amid lower retail prices Crisil Ratings says in its research.

Says Rushabh Borkar, Associate Director, CRISIL Ratings, “The overall working capital of the diamond polishers will reduce 30-40% this fiscal on a diminished scale of business. Though their receivables cycle currently is under control at ~90 days, some polishers could face a stretch depending on their position in the value chain and their counterparties. This remains a monitorable.”

Reduced working capital borrowings will bring the overall indebtedness, or the ratio of total outside liabilities to tangible net worth, down to ~1 time as on March 31, 2024, from 1.3 times a year back. However, a dip in profitability will reduce the interest coverage to ~ 3 times this fiscal from over 4 times last fiscal. This will exert pressure on credit risk profiles. All said, Crisil is of the view that the effect of sanctions on Russia and the ongoing conflict in the Middle East will bear watching.