Summary
Does Zale's higher stock prise signal a arecovery or is it a consequece of the companies instability? Here's more.
Analysis
Both Zale and Signet’s stock values have significantly increased over the last 60 days. Just what those increases are due to remains to be seen. However, here are some thoughts on the increases specifically and the outlook for the jewelry industry in general.
Zale stock values plummeted below $1.00 per share in February as institutional investors abandon the jeweler in favor of companies likely to achieve higher earnings growth. In the process, the large amount of selling drove prices down. With the exception of Richard Breeden, manager of the hedge fund Breeden Partners and a Zale director, most of the Zale’s traditional big institutional investors sold most, if not all, their stake in Zale Corporation. Now, Zale’s investors typically range from penny stock players and day traders to large speculative investors looking to make a “quick” profit as Zale’s equity prices wanders aimlessly in constant play.
In some regards, Signets move from the London Stock exchange to the New York Stock Exchange was prophetic in that it coincided with Zale's equity price demise. Not surprisingly, Signet’s share price has increased significantly, as demand for the stock drove prices higher. Now, about 66% of Signet’s equity is owned by many of the same large institutions that once owned Zale.
Clearly, there have been some winner and losers as the ownership pool changed during the first quarter of 2009, but that was a onetime gain as investors reshuffled the deck. Now, further appreciation in Zale stocks price depends more on performance than the changing geography of investors.
Is the Jewelry Business Improving?
That answer depends on your starting point. If the comparison is with December 2008 sales numbers, then current jewelry sales are better. Indeed, some analysts are suggesting the large declines between 18% and 35% were the bottom and sales are now recovering. However, that’s a bit simplistic. The fact is specialty jewelry sales declined about 14% during the first quarter of 2009, which is clearly an improvement over November-December 2008 sales.
Still it’s a whopping decline and doesn’t necessarily represent a return to growth. For instance, according to government numbers, specialty jewelry store sales declined by about 12.0%, 13.0%, and 16%.0 for January, February, and March 2009 respectively. That suggests a negative growth trend if January 2009 is used as the initial point. In other words, third and fourth quarter jewelry sales could decline as much as last year, which is in stark contrast to the optimistic view being proffered today.
Increasing Costs and Less Income Too.
Consumers are likely to see higher costs during the third and fourth quarters. For example, gasoline prices are increasing since their earlier lows and are projected to continue to increase to about $2.50 per gallon by year-end. While that may be less than last year, any increase in current costs reduces consumer’s discretionary income today and is almost certain to reduce discretionary spending, especially on jewelry.
Moreover, food prices remain higher this year, as does health care and educational costs. About, the only thing that is cheaper is automobiles and air travel, which ironically is a direct competitor with jewelry as a luxury gift.
This year jewelers are also up against sales generated from last year’s stimulus rebate program. Then, millions of US households received $600 to $1,200 between May and September to increase consumer spending. Just how much of the last years jewelry business can be attributed to the stimulus money are uncertain, but what is certain, is that the program isn’t matched off this years.
Reduced Credit Lines
Historically, jewelry stores like Zale and Kay depended on credit to sell from 30% to 60% of sales. Part of those sales may be in jeopardy in 2009 since banks have increased lending standards, closed marginal credit card accounts, reduced credit limits, and cut home equity credit lines.
This means jewelers will not only lose some credit dependent sales, but average credit sale prices will be lower too. It is not hard to do the math, lower average credit sales mean more unit sales are necessary to break even with last year’s numbers. But where are those extra sales going to come from?
Higher Jewelry Prices
Gold prices are about 4% higher on average this year. That means wholesale and manufacturer prices may be higher too. That contradicts first quarter PPI numbers which shows little if any inflation in wholesale jewelry prices. That’s probably due to the fact retailers have bought very little since December 2008 and because manufactures had excess goods in the pipeline left over from 2008 and from after Christmas returns.
Still commodity prices are higher now and will probably continue to increase in the third and fourth quarters, meaning increased inflation for jewelers and consumers alike. Some of the precious metal price increase may be offset by declines in diamond prices, but the price of gold is increasing faster than small diamond prices have declined, at least right now.
It’s now less one week before the large Las Vegas jewelry show opens and gold is actually up about 6% over the previous year. That has to concern jewelry storeowners and chain store managers as they begin buying for Christmas 2009. Realistically, consumers are likely to see higher prices this year, which is exactly the opposite of what they expect given that jewelers have been offering deep discounts almost continuously since November 2008.
The alternative, manufacturers and jewelers must absorb the higher costs and settle for even lower margins. Still, if costs increase much above their current levels, neither manufacturers nor jewelry companies are likely to have the operating leverage sufficient to take in the increases, leaving little choice but to raise prices this fall. The question is will sales drop off more than gross profits increase because of higher prices.
Another Price War
Zale led a price war last year dropping margins to about 44% only to watch sales decline about 18%. Management says they won’t make that mistake this year. But, that remains to be seen. Most jewelers didn’t catch on that jewelry demand was plummeting until mid December 2008. That gave Zale an early competitive advantage. The industry isn’t likely to give big jewelers that advantage this year.
Good news for consumers that are expecting even lower prices this Christmas, sure, but, where does that leave big public companies like Zale and Signet. Simply put, in trouble. For instance, Zale in particular is in a vulnerable position. The company is up against 4%-5% sales increases last year and about 48% margins for their third and fourth quarter. Signet reported that US sales had declined about 2.6% for its first fiscal quarter versus last year. But Signets last year sales were considerably weaker than Zale because the company had increased prices and its margins were less promotional.
This year Signet prices were lower because of higher promotions. However, Zale doesn’t have that much flexibility this year. If it lowers margins, it is likely to chase sales downward as it did last Christmas. On the other hand, if it holds margins or increases them, sales may drop off faster than GP increases because of lower absolute demand and higher competitive discounting. Yet, lower absolute operating costs because of staff cuts and store closures may help, provided lower sales don’t deleverage operating margins first.
A similar scenario holds for Zale’s first and second quarter of 2010, only to a greater degree. The company is up against lower demand with little room to lower margins to drive sales. Add that the competitive environment is likely to be even more hostile in all of Zale’s markets and its not too difficult to expect a similar performance to last year unless the company can demonstrate a way to steel market share this year that it didn’t have last Christmas.
Pundits suggest the company will pick up market share from Fortunoff, Whitehall, and Friedman customers. But, the benefit of those closures have already been factored in to first quarter specialty sales results, suggesting a negligible benefit at best for the industry in general. Zale is scheduled to report third quarter sales and earnings on May 27, which should provide a better basis for future analysis.
The Industries Defining Moment
Jeweler companies has been surprisingly resilient despite the severity of the recession. With the exception of ChrisBernard, Fortunofftian , and Robbins Brothers, cost cutting and massive discounting has kept many jewelers out of bankruptcy. Still, seventeen months of recession has taken its toll. Now, inventory levels are lower, store hours at minimums, HO and marketing costs reduced, and cap-ex limited to maintenance. Add that asset base lenders have cut credit lines and it should come as no surprise that many jewelry companies have little wiggle room remaining to materially cut costs if sales continue to decline. Christmas 2009 will be a defining moment for many retail jewelers, wholesalers, and manufacturers, which only serves to emphasize the virulence that may define the competition this fall.
