Summary
Tiffany's results may have benefited the sector, but inflation, higher gold prices, inventory liquidations, and business restructuring leave year end results in doubt. Here is why.
Analysis
Retail jewelry company shares trade higher on news that Tiffany’s earnings beat analyst’s expectation. The biggest winner was Tiffany whose stock increased by about 13.5%, but most other jewelry company’s stock also increased. Tiffany’s performance was aided by strong sales in its New York flagship store, as well as, increased growth in jewelry sales overseas, primarily because of the week US dollar. It also benefited by a menagerie of one time events, including the gains from the sale of its London and Tokyo properties which were off set by write downs in watch inventory, the sale of Little Switzerland; charges against it retail pearl business, Iridesse, and the charge off of debts owed by a rough diamond affiliate.
Overall, jewelry sector investors should have walked away from Tiffany’s earning announcement with several thoughts and questions. First, overseas and tourist sales were driven by a weak dollar which off set weak in land domestic store sales. Second, the company strengthened its balance sheet. Third, do weak sales in its US stores and problems in Iridesse, suggest a weakness in the company’s US strategy to open nearly 200 smaller format stores and fourth, what is the potential downside to the joint venture with Swatch for the remarketing of Tiffany branded watches overseas?
Blue Nile’s stock value also increased, rising about 12.9%. However, the reason why wasn’t that clear. Blue Nile’s price plummeted early in the year despite the company’s record performance both during the fourth quarter of 2007 and for the year. Many felt the company was just over valued, while others believed they could not repeat their stellar performance in 2007. Management’s guidance was also conservative saying they were targeting 12 overseas growth markets in 2008. That may be why investors drove Blue Nile’s stock price up. After all, a weak US dollar had been instrumental in Tiffany’s overseas sales growth in 2007. However, Blue Nile does about 5% of its business overseas, which means it would have to double its international business to offset a 10% decline in US business and increase it by more than six times to achieve the same growth rate as in 2007, both of which is unlikely to happen in 2008.
Share prices of Zale also increased about 4.6%. Selling for more than 30X earnings, something more than Tiffany’s performance is driving this company’s share value. Traders are probably looking at some kind of cash flow model to show the stock is under priced. However analyst’s models may be wrong. A detailed analysis of Zale’s cash flows by Coomes et al demonstrated Zale was substantially over valued as of November 2007. Also, short term cash flows that can’t be sustained without impairing the business are intrinsically hard to value. Last, Zale’s cash flow has declined over the last 4 years and the current reduction in expenses, if achieved, won’t change that trend. Zale Corporation will require an operational turn around to support its current value and a new strategic plan to add real value to its stock.
Signet Group PLC stock price increased too about 5.6%. If high tide raises all ships, then Signet benefited as the sector increased. Unlike Zale, Signet is a well managed company showing consistent growth in sales and earnings. Unlike Zale, Signet has consistently paid dividends over the last 10 years. While 2007 sales were soft because of declining consumer demand, the company’s merchandising and growth programs in the US should position it to gain substantial market share as the economy improves. In a market share management industry, that’s bad new for Zale and its investors.
Notwithstanding Tiffany’s good news, rising operating costs because of inflation and higher product costs because of increased gold prices will make 2008 a tough year for the retail jewelry industry. Friedman Jewelers, controlling nearly 500 stores has already filed for bankruptcy as has Fortunoff. Finlay Enterprises has lost more than 140 of its lease departments. Zale is closing 105 stores and plans to liquidate more than $200 million of retail inventory. Finlay will have to sell off about $150 million of retail inventory over the next 12 months to maintain its liquidity, while Freidman could be selling most of its $500 million in retail jewelry. That’s nearly one billion dollars of retail inventory that will destabilize the market and drive down prices. Meanwhile, gold has increased another 20% since the end of December 2007 which will put more pressure on retailers to raise prices to support dwindling margins.
Ironically, consumers will probably be the big winners this year, at least those that aren’t working just to buy gas. The losers will be the industry which will find it difficult to raise prices in the face of so much distressed inventory in the market place. Too much inventory chasing too few customers; at least that’s how the first quarter is shaping up.
