Implications
The jewelry industry is consolidating, but not the way many investors thought. Here's are some of the winners and losers in this battle for market share.
Analysis
Several years ago, many jewelry industry analysts thought large chains would put many of the independent jewelers out of business. They thought the industry would follow department store trends and consolidate around a few big players. Twenty-four months later, it looks like they were right, at least in part. The industry is consolidating, but the losers aren’t the smaller jewelers, but the large middle market chains. The fact is small jewelry businesses, that is companies with three or less stores, remain very viable in local and regional markets. At risk are larger middle market chains where the economies of scale aren’t sufficient to offset higher store operations and buying costs.
One such example is Friedman Jewelers which liquidated about 400 stores under several trade names earlier this year. Now it looks like Finaly Enterprises and Whitehall Jewelers are also at risk as the 2008 season evolves. Add Zale Corporation to the list of struggling chains and its clear the competitive landscape of the industry has already changed and will continue to do so in the far seeable future. Here’s a brief look at the challenges facing the largest department store jewelry operator, 2nd largest and 4th largest specialty jewelry chains as this season progresses.
Finlay Enterprizes: Standard & Poor’s downgraded its credit rating for Finely Enterprises and its subsidiaries from B- to CCC. That change puts Finlay’s long term debt squarely in the middle of the junk bond classification. Officially, the rating means the company’s viability depends on a favorable business environment. Favorable isn’t how most retail analysts would describe today’s business climate. So Finlay’s equity investors and debt holders have substantial risk that company could have to be restructured in 2008 or early 2009.
Whether that happens depends in part on trading conditions, but more importantly on short term lenders and trade creditors willingness to support the company’s inventory build up for the 2008 Christmas season. Already highly leveraged, Finlay borrowed $200 million to buy Bailey Banks and Biddle from Zale Corporation in November 2007. That acquisition not only increased the company’s debt, but increased the businesses working capital requirements.
From an investor’s point of view, Finlay’s equity is likely to become even more risky. According to the company it received notification from NASDAQ that it’s stock price was below the minimum requirements for continued listing on the exchange. Currently trading at about $0.61 per share, it's problematic whether the company can convince the market its share valuation should be higher; especially given the current business environment and the reduction in S & P’s credit rating. If Finlay’s equity is delisted, the company will have no other alternative than offering it on the OTC exchange; limiting liquidity. But Finlay isn’t the only large, public, jewelry company to have problems.
Whitehall Jewelers: Whitehall Jewelry Holdings is facing continued losses in the face of increased debt. Whitehall is the 4th largest specialty jewelry company trailing Signet, Zale, and Fred Meyer Jewelers (Kroger). Whitehall announced increased operating losses for its fourth quarter period ending February 2008. Most recently, Whitehall purchased 78 jewelry stores from Friedman Jewelers during their Chapter 7 liquidation.
Now operating 375 stores in about 40 states, Whitehall is a business in transition. Originally catering to up market diamond, brand conscious consumers, the business was sold after which the new owners repositioned the company’s product offer to the middle of the market. Now the company competes head on with the likes of Zale, Gordon, and Kay Jewelers to name just a few. It’s a crowed marketplace where store differentiation is difficult to achieve. To make matters worse, most of Whitehall’s stores are physically much smaller than the typical mall jeweler. That limits assortment breadth, as well as, product and brand variety, a disadvantage that is marginally off set by lower fixed rents. The company’s acquisition of larger Friedman stores will help improve average store productivity, but has also increased debt and working capital requirements.
Realistically, whether Whitehall has a future remains to be seen. The middle market is already over stored and Whitehall’s offer isn’t that compelling. Small assortments, average pricing, average quality, and average locations is about the best description of the business. Add to that, the company is undercapitalized and you have a recipe for failure, especially in this economic environment. Then there is Zale Corporation.
Zale Corporation: Zale operates about 2100 locations in the US and Canada under five trade names, the largest of which is Zale Jewelers. Zale’s sales have been declining for years. Now the company is losing money. Currently, new management is closing stores, liquidating inventory, reducing costs, cutting marketing and cap-ex spend, all while increasing company debt to buy back stock and prop up the share price. Frankly, there is no top line turn around insight, at least in the foreseeable future. If the economy turns around soon, and that’s a big if, company sales may flatten out. Otherwise there is every expectation the company will continue to perform very poorly. That leaves Zale Corporations future in question too.
I think it goes without saying that the company is for sale, but there aren’t any buyers. Signet Group looked at the company in the summer of 2006, but the parties couldn’t come to an agreement. Since then Zale has gotten weaker, sold off its luxury division, and centralized operations, buying, and merchandising functions to reduce cost. Still it’s losing money. With no buyer insight and facing another weak Christmas season, the company will probably close even more stores in 2009 and look for a buyer of either it’s Gordon stores or Canadian Division. In either case, this Christmas probably marks the end of Zale as a meaningful competitive threat to other industry players.
What does all this mean? For one thing, it looks like Kay (Signet Group Plc) will be the big middle market winner in the US. If the company implements its plan to move its primarily stock listing to the New York Stock Exchange, US investors could benefit from higher multiples and increased trading liquidity. Kay could then run the table on its nearest competitors. Zale’s Canadian stores would be a great acquisition, so too would be any of a number of well positioned up market jewelry competitors. You will note I didn’t say Zale would be a good buy. I still believe any one time cost advantages from buying Zale stores would be more than offset by the cannibalization of future sales in the duplicated markets, future store closures as the markets were rationalized, and increased future operating costs.
Other winners would also include some large and mid-sized up market jewelry chains. For instance, Tiffany has begun rolling out it small format stores in California. These stores will benefit from fewer competitors for aspirational products, as well as, less market clutter, making it easier for them to frame their new offer to consumers. Other mid-sized luxury jewelry chains could also benefit such as Helzberg Jewelers and Fred Meyer Jewelers. Operating about 270 and 396 stores respectively, these two better jewelry companies are owned by Berkshire Hathaway and Kroger.
However, the largest beneficiary will be many of the 24,000 independent jewelers and small jewelry chains. Closer to the customer and more specialized, these stores are positioned to benefit the most as the number of mid-market, large jewelry chain competitors decline and consumers become more discriminating in the face of higher prices and less discretionary income.
