Inventory Reductions May Not Be Sufficient to Rescue Finlay

Implications: In spite of renewed contracts with Macy's, Finlay continues face declining cash flow because of lower comp store sales and dwindling store base.  The company's efforts to maintain liquidity by liquidating excess inventory may not be as successful as investors believe.  Here is why.

Analysis: Finlay Enterprises announced that it has extended its deal with Macy’s to operate their jewelry departments for at least 2 years.  That’s about 222 jewelry departments that Finlay could ill afford to lose.  However, the two year lease period is still cause for concern for investors.  

Macy’s may well have already decided to bring all their jewelry buying in-house in 2010.   That’s what Lord and Taylor is doing after its parent, private equity firm NRDC Equity Partners, bought Fortunoff out of bankruptcy in February.  Evidently Fortunoff’s stand alone jewelry buying division will operate Lord and Taylor’s 44 jewelry departments.  

Department store management has to be concerned about Finlay’s liquidity; especially in a declining economy.  Earlier, Standard’s and Poor’s rating company said the loss of 94 Macy’s stores would have “no immediate impact” on Finlay’s. But that was before Finlay lost about $44 million in revenue from Lord &Taylor’s jewelry business.  

Finlay, already highly leveraged, went into debt even further when it purchased Bailey, Banks, and Biddle from Zale in November 2007 for $200 million. The deal was financed by an extension of the company’s working capital line from GE and a series of debentures.  Now, Finlay will have to liquidate the inventory from the 94 Macy’s departments it is losing, as well as, the 44 Lord and Taylor stores to pay down its revolver and make interest payments.  

Unfortunately for Finlay, other large retail chains are also selling off unwanted inventory too.  For instance, Zale Corporation recently announced it was closing about 105 stores this spring and cutting inventory by at least $200 million at retail.   Friedman Jewelers also said it planned to start a going out of business sale in March as a part of a court ordered Chapter 7 liquidation. 

In total, more than three quarters of a billion dollars of retail inventory will be sold off by jewelry chains and department stores during 2008 based on events through the first quarter.  That not only means it will take longer for Finlay to get the cash it needs to pay down debt, but it may incur higher markdowns too.