Asian Star Company Ltd Management Discussions.

ECONOMIC OVERVIEW

Global economy

Following a strong growth in 2017 and early 2018, the global economy contracted in the second half of 2018 amidst trade policy uncertainty and subdued performance across several economies. Resultantly, global economic growth dipped to 3.6% in 2018 compared to 3.8% in 2017. Heightened trade tensions and tariff war between the United States (US) and China, uncertainty in Eurozone over Brexit deadlock, tighter financial conditions and policy uncertainty across advanced economies and emerging markets were the major contributors to the weakness.

Economic growth in the Advanced Economies remained softer at 2.2% in 2018 vis-a-vis 2.4% in 2017. The US economy stood out with growth of 2.9%, in comparison with 2.3% in the previous year, aided by robust consumption growth. This impressive performance marked an acceleration of economic activity amid a tight labour market and moderating investment climate. The Euro area witnessed sluggish growth of 1.8% compared to 2.4%. Activity softened primarily due to muted consumer and business confidence, disruption in car production in Germany owing to new emission standards and fiscal policy uncertainty, elevated sovereign spreads and declining investment in Italy. Additionally, growing concerns about a no-deal Brexit weighed on investment spending within the Euro area.

Emerging Market and Developing Economies grew modestly at 4.5%, after recording a robust growth of 4.8% in the previous year. Led by slower investment, faltering domestic demand and surging US tariffs, Chinas growth declined from 6.8% in 2017 to 6.6% in 2018. Geopolitical tensions led to weaker activity in the Middle East. Elsewhere, across Argentina and Turkey, the worsening global financial market sentiment and policy tightening softened the growth momentum.

The International Monetary Fund (IMF) expects the challenges in the global economy to persist in the first half of 2019. Consequently, global economic growth is anticipated to slow down to 3.3% in 2019. Buoyed by improvements in the world economy starting second half of 2019, growth is expected to pick up to 3.6% in 2020. Improvement in global financial markets, accommodative monetary policy stance by the US Federal Reserve, ongoing fiscal stimulus in China, fading of temporary bottlenecks in the Euro zone, expectations of a positive outcome of US-China trade negotiations and gradual stabilisation in stressed emerging economies are expected to drive economic growth in the year ahead.

However, growth in the US is projected to decline slightly in 2019 with the unwinding of fiscal stimulus and protracted government shutdown. Despite this, strong domestic demand is likely to support growth. China and India continue to remain the fast-growing major economies. Indian economy is poised to grow in 2019, benefitting from lower oil prices, moderate inflation and expected impetus from fiscal policy. Partial recovery in commodity prices is likely to augur well for commodity exporters.

Despite the moderate outlook, the global economy will continue to face downside risks led by several factors. Trade and geopolitical scenario will be the key factors to watch. Risks surrounding Brexit, increasing propensity of countries towards inward looking policies and rebuild up of trade tensions and its extension to other sectors have the potential to weigh down growth. Further, large private and public debt in several countries pose financial vulnerabilities. There will be greater neccessity to take right policy decisions.

Indian economy

Indias Gross Domestic Product (GDP) grew at 6.8% in 2018-19, as per the data released by the Central Statistics Office (CSO) estimates. Growth was lower than 7.2% achieved in 2017-18. With key economic policies on track, the Government is likely to focus on their faster implementation. Greater emphasis will be placed on strengthening infrastructure and agriculture development, supporting systemic credit growth and accelerating private sector investment and consumption.

Macro-economic fundamentals have been supported by the implementation of structural reforms, including Insolvency and Bankruptcy framework, GST and the thrust on infrastructure and rural development. This helped foster an environment that boosted investments and eased banking sector concerns. These momentous reforms have translated into significant progress for the economy. India has jumped 23 notches in the World Banks "Ease of Doing Business" ranking to attain the 77th position among 190 nations. India remains one of the fastest-growing major economies and is expected to rank amongst the worlds top three economic powers over the next 10-15 years.

The Interim Union Budget 2019-20 focussed considerably on agricultural development, relief to the middle-class, healthcare for the marginalised and economically weaker sections, infrastructure creation and the ease of doing business. Prediction of normal monsoon and income support package are expected to augment rural spending and consumption. Lower oil prices, benign inflation and recent appreciation of the Indian rupee will lead to further sustainable economic expansion.

Going forward, IMF estimates Indias economic growth to increase to 7% in 2019-20 and 7.2% in 2020-21, aided by a recovery in investment, robust consumption and resilient export performance. This projection, however, is lower by 0.3 percentage points than earlier estimated owing a weaker than expected outlook for domestic demand and low investment. Private investment which has been declining consistently due to corporate debt overhang, is especially an area of concern. Liquidity is a challange as the banking sector is grappling through bad loans crisis and making the matters worse is the liquidity crisis among NBFCs. Key sectors of construction, real estate and automobiles are witnessing imminent challenges which is preventing take off. The scenario demands the Government to come up with policies and initiatives conducive to growth; higher capital infusion, revival of public private investment and job creation.

INDUSTRY OVERVIEW

Global Gems and Jewellery Industry

The Global Gems and Jewellery industry after growing steadily over the last few years led by technology advancement, increasing premium product launches and robust consumer demand witnessed some moderation in 2018. Trade wars amongst the worlds largest jewellery markets of the US and China led to some unrest and hence slowdown in several global markets, especially China and Middle East. Though demand in the US which accounts for more than half of the global diamond jewellery market remained strong.

Demand in the US is likely to continue further on the back of healthy GDP growth, employment and wage growth and strong private consumption expenditure. However, the markets of China and India are slowing down. In China, sustained impact of trade wars and the ongoing political unrest in Hong Kong will impact the market. In India, huge unsold inventory along with subdued international demand for polished diamonds led to a sharp decline in rough imports. Following this, De Beers, the largest diamond mining company has also lowered its production forecast for 2019 to 31 million carats from 35.3 million carats in 2018.

Indian Gems and Jewellery Industry

The Gems and Jewellery industry continues to play a vital role in the Indian economy with contribution of around 7% to its GDP and 15% to total merchandise exports. The industry, one of the largest in the world, currently employs more than 4.5 mn people and is estimated to be providing employment opportunities to over 8.2 mn people by 2022. The industry is one of the leading foreign exchange earners for the country. The gross exports of gems and jewellery stood at USD 40 bn in 2018-19. UAE, US, Hong Kong, Japan and Europe continue to be the biggest export destinations of the Indian gems & jewellery with the US accounting for nearly one- fourth of the countrys total exports.

Given its huge growth potential, the Government has identified the sector as a key focus area for export promotion. It is undertaking proactive steps to accelerate investments, upgrade technology and skills and promote ‘Brand India in the international market. Favourable measures such as 100% Foreign Direct Investment (FDI) and setting up of a huge jewellery park in Mumbai will provide further impetus to the sector. Gem & Jewellery Export Promotion Council has embarked on its initiative of setting up a Common Facility Centres (CFC) in collaboration with the Union Ministry of Commerce and Industry, opening the first facility in Coimbatore, Tamil Nadu. This initiative will go a long way in increasing productivity and improving quality of finished goods.

Cut and polished diamonds

India continues to be a world leader in manufacturing of cut and polished diamonds. Today, 14 out of every 15 diamonds sold in the world are processed in India. The countrys share in global diamond market stands at 65% in value terms and 85% in volume terms. Besides, its known expertise in small sizes, it has been rapidly gaining recognition for manufacturing of diamonds of larger sizes and fancy shapes and cuts. Most importantly, India has the twin advantage of cost-effectiveness and highly-skilled labour for diamond processing and is buttressed by leveraging modern techniques. Its unique geographic location makes it an ideal one-stop sourcing centre for overseas buyers. As per GJEPC, exports of cut and polished diamonds stood at USD 23.8 bn during 2018-19, marginally higher than USD 23.7 bn in 2017-18.

Jewellery

Jewellery manufacturing has gained prominence in the last few years with India increasing its capabilities in producing machine made jewellery for mass consumption besides continuing its legacy of being one of the best in handmade jewellery in ethnic as well as contemporary designs. This along with the Governments sharp focus on establishing the nation as a leading exporter of gold and diamond jewellery is enabling the country to steadily becoming a fast-growing hub for the global jewellery market. Further, the Government has been extending support to the industry by initiating various measures including artisan skill development and encouraging promotion of branded products in the international market. As a result, the Jewellery exports grew by 24.36% to USD 12.02 bn in 2018-19 as compared to US$ 9.7 bn in 2017-18. The US continued to be the largest consumer of diamonds and jewellery globally. India catered to over 16% of the gems and jewellery demand in the US during 2018-19. Exports from India to the US rose to USD 10.48 bn during the year, up from USD 10.1 bn in the previous year, registering a growth of nearly 4%.

The domestic jewellery market is witnessing an influx of established brands. These brands are not only guiding the organised market, but also creating new growth opportunities. Given the demographic transformation and increasing disposable incomes in India, a larger number of people today prefer branded jewellery. The organised retailers, too, are stepping up marketing and branding initiatives to promote growth and increase market share and lead to exponential growth in the organised jewellery market. Increasing penetration of organised players implies wider and exclusive collection of unique and authentic products.

Outlook

The outlook for Gems and Jewellery industry appears promising in the long-term, though there are likely to be several short to medium challenges. Dwindling global economic scenario, geopolitical crisis in Hong Kong, and over-supply in the diamond market are likely to weigh down sentiments. Demand in major diamond consuming countries such as the US and India is seen augmenting on account of high demand, growing e-commerce sales, improved consumer confidence and continued investments in marketing and branding initiatives.

India is one of the fastest-growing large economies with a strong growth rate, a momentum that is estimated to sustain over the next decade. Recent positive developments in the domestic economy bode well for the industry. Governments conducive policies to support economic growth will lead to higher disposable incomes, credit growth recovery and spike in rural spending. Further, the ongoing trade war between the US and China, whereby the US raised import duties from China, is likely to benefit India. India with its inherent advantage will be well-placed to capitalise on the opportunity. A combination of all these factors will boost consumption, and augur well for the jewellery industry. However, following the recent defaults in Indias diamond industry, banks have tightened credit requirements.

Nonetheless, credit availability has eased for transparent and financially healthy jewellery players. Going ahead, revival in economic environment and growing presence of organised and branded players will propel industry growth.

Under the Vision 2025 programme, the Government has envisaged a target of USD 100 bn for the indigenous gems & jewellery sector, up from the current USD 75 bn. Policy initiatives are aimed towards invigorating the sector, maximising employment opportunities and uplifting exports. Implementation of the new GST regime has translated into significant growth opportunities for organised players. Looking into the future, growth in the sector will primarily be led by penetration of large retailers and brands. Further, online sales are expected to account for 1% to 2% of the fine jewellery market by 2021-22. Growth in online jewellery is increasingly being driven by availability of low-cost jewellery and rising internet penetration rates.

COMPANY OVERVIEW

Asian Star Company Limited is amongst the worlds leading conglomerates delivering quality diamonds since 1971. Headquartered in India, the Company has emerged as one of the leading diamantaires with vertically integrated operations spanning across the entire value chain encompassing sourcing of rough diamonds, diamond cutting and polishing, jewellery manufacturing and distribution and jewellery retailing.

The Company has an extensive global presence with its widespread marketing network in the worlds major diamond consuming cities, namely Chicago, New York, Antwerp, Dubai, Shanghai, Hong Kong, Bangkok and Singapore. Supported by a sophisticated infrastructure, highly qualified personnel and dedicated R&D, the Company has cemented its reputation as one of the most trusted and renowned diamond manufacturers. The Company has an arrangement of direct supply of rough diamonds from the top global mining companies. Besides, it has become an approved manufacturer of the worlds leading retail brands, reiterating its expert craftsmanship and enduring commitment to quality and integrity.

Manufacturing Facility for Polished Diamond

The Company has a world-class state-of-the-art manufacturing facility spread over 1 lakh sq. ft. at Surat, Gujarat in India. Engaged in polishing of diamonds, this high technology facility employs over 1000 skilled artisans. With over four decades of industry experience, the production team is immensely skilled to manage the complexities of diamond cutting to achieve optimal yield and deliver supreme value to the client. Aligned with the global diamond industry norms, the Company provides conflict-free natural diamonds to its clients. Specialising in customised proprietary cuts, the Company has an extensive portfolio of diamonds ranging upto 5 carats in size, and available in all colours and shapes. The Company is recognised for its consistency in quality and cut and its products are acknowledged as ‘Asian Star Make in the industry.

Manufacturing Facility for Jewellery

The Company has strong competence in jewellery manufacturing, complemented by three manufacturing facilities - two located at SEEPZ and MIDC in Mumbai; and one at Hosur in Tamil Nadu. The manufacturing units are spread across a combined area of 50,000 sq. ft. and are equipped with a production capacity of 7.5 lakh pieces a year. The facility at SEEPZ caters exclusively to the international markets. The jewellery designed here is customized to local trends with trademark precision. The facilities situated at MIDC and Hosur serve the domestic markets. Proven expertise, robust infrastructure, passionate team of creative designers and skilled artisans and advanced technology enables the Company to create resplendent jewellery. The Company follows lean manufacturing processes to minimise production cycle and deliver highest quality products at most competitive rates.

Distribution

The Company has strategically positioned itself in major diamond trading and consuming centres in Asia, Europe and America with an extensive network of subsidiaries and marketing arms enabling it to create bespoke products. The Company firmly believes in offering the best technical and marketing services in the industry. It provides differentiated services such as specialised quality control programme, access to extensive design bank and design customisation as per market needs. Further, access to information on latest market updates and global design trends enables the Company to innovate and design as per evolving market trends and better serve its clients. With this client centric approach, the Company has established long-standing and trusted relationships with the worlds leading brands and retailers.

Retail

In the niche jewellery retailing segment, the Company has a spacious and luxurious couture diamond boutique, catering exclusively to high net worth individuals (HNIs). Besides offering a wide range of pret diamond jewellery, it undertakes customised orders with jewellery design consultations for special occasions to suit the preferences of discerning customers. The Company also hosts

"Rendezvous Luxe", its annual luxury event and a couture diamond jewellery extravaganza for Mumbais elite to showcase its exquisite diamond jewellery. The design conceptualisation for its collections is thematic and inspired from varied sources such as nature, art and history.

FINANCIAL OVERVIEW

2018-19 was a year of consolidation for the industry and the Company as well. Challenges were many - rising rough prices, sluggish demand in the major consuming centres like China and Middle East, liquidity crunch etc. Hence, margins in diamond segment were under pressure. To overcome the challenge, the Company increased focus in the jewellery business where profitability and potential for growth is higher. The Companys total Income from Operations at consolidated levels stood at Rs. 3,642.19 crores in 2018-19, down 7% from Rs. 3,905.03 crores in 2017-18. The diamond business reported a top line of Rs. 3,041.77 crores in 2018-19, as against Rs. 3,344.04 crores in 2017-18, marking a de-growth of 9.04%. Jewellery business sales grew by 7.18% from Rs. 554.59 crores in 2017-18 to Rs. 594.39 crores in 2018-19. Consolidated PAT (excluding exceptional items and comprehensive income) increased 4% to Rs. 118.40 crores in 2018-19 from Rs. 114.16 crores in 2017-18. The Companys strategy of focusing on the profitable and healthy business has enabled it to generate better profits despite a fall in the revenue. The consolidated net worth of the Company stood at Rs. 1,073.52 crores at the end of the period under review.

OPPORTUNITIES Increasing demand in US

The US market is undisputedly the worlds largest jewellery market and represents more than half of the global diamond jewellery market. Solid growth in disposable incomes and greater consumer spending are likely to augur well for the jewellery industry in the country. The US jewellery market is largely fashion driven. Demand for low-cost modern jewellery will accentuate growth of fashion-driven jewellery products. Moreover, diamond studded jewellery is also contributing to evolving fashion trends of growing millennials in US.

E-commerce

The E-commerce industry is expanding rapidly, and the jewellery industry is one of the fastest contributors to its growth. The exponential growth in the online space and increasing popularity of affordable jewellery is increasingly compelling top jewellery players to foray into e-commerce platforms. A wide range of jewellery, with multiplicity in design and materials, quick shipping, numerous payment options, better price and return policy, attractive discounts and quality assurance are the key factors motivating traditional jewellers to shift to e-commerce channels without the need for physical infrastructure. Today, online shopping of jewellery has become more comfortable with technological advancement and smartphone penetration. It empowers the jewellery industry to reach out to a larger target audience, offer jewellery at reasonable prices and boost sales.

Favourable domestic demand

Following disturbance caused by demonetisation and GST, the jewellery segment is showing signs of stability and recovery. The industry is on a high-growth trajectory with changing demographics, rising middle-class population, higher affluence, continued urbanisation and spurt in income levels. Millennials and post-millennials are shaping up the future of the jewellery industry. For the diamond industry, millennials are an important consumer segment. They prefer buying jewellery for fashion rather than for investment. There has also been a perceptible transition in demand for jewellery from wedding and festivals to regular wear and gifting purposes. That apart, diamonds continue to be the most desired precious gem amongst the younger generation for bridal jewellery and engagement. Growth is further fuelled by women empowerment and their willingness for higher spending on fashion statement. Going ahead, GST has been leading to formalisation of the economy, providing ample headroom for growth to organised and branded players. On the macro-economic front, easing inflation, normal monsoon prediction and increasing investments are expected to spur private and rural consumption, and in turn, boost demand for jewellery.

Government thrust

The Gems & Jewellery industry is one of the largest industries in India and plays a crucial role in the economy. The industry is extremely export-oriented and labourintensive and throws tremendous growth opportunities. In view of this, the Government is focussed on creating a conducive environment with favourable policies and measures supporting growth. The Governments move to permit 100% FDI in the sector has resulted in cumulative FDI inflows worth USD 1.15 bn between April 2000 - June 2018 in diamond and gold segment. Gold Monetisation Scheme is aimed at reducing the countrys reliance on gold imports to meet domestic demand.

India has emerged as the hub for global jewellery owing to low costs and availability of skilled and creative workforce. Its diamond export industry has attained a leadership position worldwide. The Governments move to establish

Common Facility Centres (CFC) will be instrumental for technological and social transformation of workers and manufacturers engaged in diamond cutting and polishing activities. The launch of the Domestic Council for Gems & Jewellery will unlock the sectors massive potential with the introduction of new ideas and technologies and make the industry more organised and unified. It will also provide a forum for addressing the sectors issues and concerns through policy measures.

Further, a year after GJEPC signed a Memorandum of Understanding (MOU) with Maharashtra Industrial Development Corporation (MIDC), the gems and jewellery industry is set to get Indias first ultra-modern and high-tech gems and jewellery park in Navi Mumbai. Spread across 21 acres, the park is being developed on co-operative housing model basis and is likely to be ready by 2022. It will accommodate 4,800 large and small units across the value chain and will be a one-stop hub for all jewellery transactions. It will facilitate in strengthening exports.

Gold hallmarking standards have also been revised by the Bureau of Indian Standards (BIS) to ensure better quality of gold. All these factors will collectively provide a huge fillip to Indias gems & jewellery industry.

Preference for Branded Jewellery

Majority of the jewellery exports from India is unbranded, resulting in overseas branded jewellers commanding a larger market share. This trend is, however, witnessing a reversal. Branded players are now increasingly making relevant branded jewellery (light jewellery using low carat gold) that meet the demand of brand-conscious overseas consumers and their changing lifestyles. The move is being facilitated by GJEPC which together with the branded players is focused on establishing ‘Brand India to create market for branded Indian jewellery.

In the domestic market as well, there is a growing trend of consumers increasingly preferring branded jewellery driven by their evolving needs for elegant products with supreme quality. They demand high-quality services in an exclusive retail ambience. Trust is another important factor that is driving demand for branded jewellery. Unlike in the unorganised segment, jewellery in the branded segment have reliability in terms of material used and prices. These factors have resulted in the branded jewellery market witnessing unmatched growth.

RISKS, THREATS AND CONCERNS

Low margins

The prices of the rough diamonds continued to move upwards through major part of the year only correcting towards end of the year. This coupled with weakening rupee resulted in substantial increase in cost. The price realisation of finished goods are under pressure and not moving up in tandem with the cost due to sluggish demand. This has resulted in further squeezing of already thin margins. However, the scenario is expected to improve in the coming year. To address margin pressures, companies are increasingly focussing on deepening geographical footprint, upscaling e-commerce operations and offering innovative and differentiated products in tandem with evolving preferences.

The Companys lean manufacturing process and outstanding operating efficiencies result in minimal wastages and higher yields. Additionally, the Company undertakes contractual agreements with leading miners to source rough diamonds at competitive rates. Vertically integrated operations allow the Company to provide optimal cost solutions to its customers.

Liquidity constraints

The Gems & Jewellery industry is highly capital-intensive due to its long working capital cycle. Bank finance is the lifeline of the industry and any slowdown in funding will reduce gems & jewellery exports. The industry is facing a huge liquidity crisis, prompted by several factors forcing lenders to curtail lending and exercise caution in extending credits. Following the recent bank scam, financial defaults and liquidity squeeze in the industry, banks and other financial institutions have become stringent and are insisting on a much higher collateral security against bank finance. The liquidity crunch is severely impacting performance, sales and profitability of the industry players.

To ensure adequate credit availability, the GJEPC has taken up the issue with the finance ministry seeking its intervention to support the industry. The Company has a strong financial base and successful track record, along with a healthy relationship with the bankers. Though the Company is not immune to this, it has adequate bank facilities. Besides, it has substantial reserves and surplus of Rs. 1,057.51 crores and enjoys one of the top credit rankings in the industry assigned by credit rating agency CARE for its bank facilities.

Growing availability of cheaper substitutes

The fast-paced growth of gem-quality synthetic diamonds poses a huge threat to the industry. Considering the rising prices of diamond, lab-grown diamonds are increasingly being mixed with natural diamonds, thereby eroding the market share of natural diamonds and shrinking consumers confidence. The rapid advancement of lab-diamond production technologies is likely to fuel growth of synthetic diamonds. To mitigate the risk of widespread presence of cheaper substitutes, several organisations are investing in machines and processes to detect and prevent adulteration of synthetic diamonds. The concept of certification is rapidly gaining popularity as it gives assurance and confidence to the consumer. To mitigate this risk, the Company deploys advanced equipment to identify synthetic diamonds, assuring the genuine quality of its diamonds.

INTERNAL CONTROL SYSTEMS AND THEIR ADEQUACY

The Company has adequate and well-framed internal control systems in place commensurate with the size, nature and complexity of its business operations. The internal control framework ensures the Companys resilience and agility in a dynamic business environment. The framework encompasses various aspects of governance, compliance, audit, control and reporting. The Company regularly monitors adherence to all the systems and processes and ensures proper documentation, regular appraisal and updation by internal and statutory auditors. The internal controls ensure the following:

- Effective use and safeguard of resources

- Stringent adherence to policies, procedures and statutes

- Accuracy and completeness of financial reporting

The internal audit is reviewed by the senior management who ensures strict compliance. The audit minutely monitors all business operations and ensures that variances are promptly reported to the Management. Without any exception or concession, all environmental norms, legal rules and statues are strictly adhered to. Constant review and updation of systems is the primary function of the Audit Committee. The Company maintains satisfactory internal financial controls pertaining to financial statements. The year under review witnessed no remarkable weakness in the design or operation.

HUMAN RESOURCES

The Company recognises its human capital as a key asset and core element of business growth and success. The human resource strategy of the Company is aimed at providing a safe, conducive and engaging work environment, wherein the employees are encouraged to pursue their passion and deliver the best results. The open-door policy of the Company ensures a transparent and inclusive work culture. Periodic skill development and training programs are conducted to build a culture of continuous learning and innovation. Employees are further motivated to directly communicate with the management and share their ideas. Key focus areas include high productivity and growth, greater employee satisfaction and engagement levels and high retention rates. Employees have a sense of belongingness and feel empowered in driving business profitability. The management has expressed sincere appreciation for the efforts of all its employees.