MARC has downgraded the long-term rating of DeGem Berhad’s (DeGem) RM50.0 million MUNIF/IMTN from A+ID to AID with a stable outlook and re-affirmed its short-term rating at MARC-2ID. The downgrade reflects the group’s potential erosion of competitive position and loss of future earnings subsequent to the disposal of a large part of its gold business to PYT Gem Trade Sdn Bhd which leads to a higher concentration risk in its operations. The downgrade also reflects the nature of the industry which is highly correlated to the domestic economy and susceptible to consumer sentiments as well as increasing pressure from keener competition. Moderating factors include the group’s continued emphasis in the diamond retail business, and its newly established wholesale business. The stable outlook reflects the group’s enlarged operations with 17 retail outlets, making it one of the leading and largest diamond jewellers in Malaysia.

The Group’s diamond jewellery retail business is undertaken by its subsidiaries, Degem Masterpiece Sdn Bhd (Degem Masterpiece), Diamond & Platinum Sdn Bhd (D&P), Degem Diamond Collection Sdn Bhd (Degem Diamond Collection) and PYT Jewellers Ampang (PYTJA). Jewelleries sold by its DeGem Masterpiece and Degem Diamond Collection are targeted towards the high end market whilst its D&P and PYTJA outlets cater to the mid to lower end market as well as the younger age groups. With different target markets, DeGem ensures that its products are affordable, catering to a broad range of income levels.

With more than 90% of its sales being derived from the domestic market, the demand for its jewelleries is positively correlated to the domestic economic cycle and therefore highly susceptible to consumer sentiments. The group’s major export markets which include Indonesia, Hong Kong and Singapore contribute less than 10% to the Group’s revenue. Although the retail industry is expected to benefit from the Visit Malaysia Year (VMY) 2007 campaign with higher than anticipated retail sales, MARC is cautiously optimistic that an increase in tourist receipts and arrivals will lead to higher demand for diamond jewelleries.

After enjoying double digit operating margin growth for the last four years, the group saw operating profit margin dipped to 8.5% as revenue fell by 20% to RM108.2 million in FY2005. The significant drop in revenue and operating profit margin was a result of intense competition arising from various promotional activities by competitors in a bid to capture larger market share. For the nine months ended 30 September 2006, the group registered a 24.3% and 89.6% increase in revenue and pre-tax profit respectively compared to the previous year’s corresponding period mainly attributed to more aggressive marketing strategies and activities. The increase in both revenue and pre-tax profit were also derived from the disposal of the group’s properties and assets. During FY2006, the group disposed two retail outlets and discontinued its operations at another outlet, all of which were operated by its wholly-owned subsidiary, PYT Jewel & Time Sdn Bhd. Excluding the one-off gain from disposals, revenue and pre-tax profit registered a 23.6% and 77.7% increase respectively as margins improved correspondingly, aided by tighter cost control.

DeGem’s net cash flow from operating activities made a turnaround in FY2005 as the group recorded positive coverage ratios. For the nine months ended 30 September 2006, the group’s cash flow from operating activities posted a deficit of RM846,000 against a deficit of RM2 million in the previous corresponding period due to a special dividend payment made during the year which amounted to RM18.3 million. Based on MARC’s sensitivity analysis, the cash flow projection is less robust towards any adverse movements in the reduction in sales as well as increase in cost. The minimum DSCR of 1.09 times is expected to occur in FY2009 due to the higher repayment of the MUNIF/IMTN in the final year amounting to RM25.0 million.

A slight improvement was noted in the group’s leverage position for FY2005 with debt-to-equity ratio at 0.32 times (FY2004: 0.36 times), thus comfortably meeting the maximum debt leverage ratio of 1.0 times imposed under the financial covenants of the issue structure. Based on the nine months results as at 30 September 2006, the group’s leverage position remained moderate as gearing increased to 0.41 times on the back of higher borrowings to finance working capital.