Summary
With about 46% of Zale's stock float sold short, short sellers will be the only beneficiaries of Goldberg's "sweeping' management changes. Here is why.
Analysis
Zale stock moved higher today on news that Theo Killion had been promoted to president of the fine jewelry retailer. Most recently, Killion was the EVP for Human Resources. He was also responsible for the company’s Legal and Corporate Strategy functions. Now as president he will direct Loss Prevention, Customer Service, and Store Operations. Excluded from his responsibilities are the critical buying, merchandising, marketing, finance, and accounting functions which will continue to report to Neil Goldberg who will remain CEO. In a separate announcement, the company also said Mary Kwan, the former Chief Merchandise Officer for the soft lines retailer Goody’s Family stores would assume the responsibility of EVP and Chief Merchandising Officer for Zale.
Evidently some institutional buyers liked the announcement as Zale stock price advanced about 13% on strong volume. Zale is scheduled to report 4th quarter and FY 2008 YE earnings on August 28th. Most analysts expect the company to report a loss between ($0.44) per share and ($0.66) per share for the last quarter of its 2008 fiscal year that ended July 31st. Moving forward, current estimates are the company will earn between $0.45 and $1.30 per share for FY 2009.
That seems very optimistic given current economic trends and the company’s deep discount driven sales base. The fact is there are few signs that consumer sending will rebound during the last calendar quarter of 2008. While, the stimulus package injected more than $100 billion into the economy, the results were mixed, especially for jewelry retailers like Zale. For the most part, higher prices for fuel and food offset any incremental buying leverage the additional income gave consumers. Now that most of the rebate has been distributed, consumers will probably spend most of it by the beginning of the October. That means the economy could slow even further during the last three months of 2008 when Zale earns nearly 100% of its annual profit.
Another stumbling block the company faces is a weak sales base. By weak, I mean the company was on sale with a combination of high discounts, rebates, and clearance events last Christmas. This year, Zale is up against the sales generated by those events with weaker assortments and an even weaker economy. Add the company has been on sale at up to 70% off for the last 7 months which will have cannibalized some future sales, as well as, set consumer pricing expectations for the fall, and you have an unusually hostile sales environment, much of which is of current management’s own making.
Unfortunately, it doesn’t get better for Zale. Most economists now believe the first three to six months of 2009 could also be weak. Zale will be up against the beginning of its $100 million inventory clearance sale which it can’t match off without continued high discounting or a significant investment in inventory in combination with margin improvement. If that hasn’t already happened by December, it’s not going to happen in Zale’s second half either. Accordingly, last years clearance sales will probably decline faster than regular margin sales increase this year which probably means more losses for the company in FY 2009, That's in contrast to the earnings turn around shareholders currently expect. Now, the real question for investors is: Are things better at Zale, the same or getting worse?
It’s problematic whether Chairman Lowe has a better handle on the company’s strategic issues than Richard Marcus, Zale’s previous chairman. Likewise, it’s hard to see how Goldberg’s selection as CEO is superior to the boards choice of either Burton or Forte several years earlier, especially after his recent organizational changes, including the appointment of a soft goods merchandiser as Zale’s chief diamond merchant. Evidently Goldberg thinks buying, merchandising, marketing, and selling fine jewelry is essentially the same as selling blue jeans, plus sized women’s cloths, and discount apparel.
If true, it's categorically incorrect and there’s a list of jewelry businesses that demonstrate it. Most recently you only have to point to the liquidation of Friedman’s 400 stores and the pending closure of Whitehall Jeweler’s 375 store chain to illustrate the point. Some would argue Robert DiNicola was an example of a non- jewelry CEO that was successful at Zale. However, despite the appearance of a turn around in the mid 1990’s, a critical examination of his department store methods suggests big box sourcing, quality, and pricing methods laid the foundation for many of Zale’s current problems. A point further born out by the recent bankruptcy of Linens and Things, another up market better goods, specialty retailer where DiNicola was last CEO.
Moving forward, as far as the company future earnings are concerned, poor mix, broken assortments, misguided styling, and rampant discounting will continue to inhibit Zale’s recovery for at least another Christmas or two as one more inexperienced soft lines merchandiser finds out too late that the experience curve in fine jewelry retailing is steeper than imagined and the business more complex than anticipated. While that’s bad news for many Zale investors, it could be really good news for speculators that have sold Zale stock short.
Selling for more than 150% of its 52 week low, about 46% of Zale’s float has been sold short. In comparison, only Blue Nile has a greater percentage of its float short sold (61%), followed by Tiffany (10%), and Signet Group (0.18%). In spite of Zale’s increasing stock price, many speculators are hedging their investment, betting Zale management will under perform, yet again, this Christmas and with good reason considering the economy, inexperienced management, and stocks previous trading history.
For example, Zale’s share price has declined by more than 11% between August 1st and January 31st over the past four years. Specifically, the stock was higher only one year out of the last four on January 31st; declining (4.4%), (27.2%), and (21.9%) in the other three years. So, short selling now could lead to big trading profits if stock prices decline after Christmas 2008 as it has in three of the last four years. If that happens short sellers will be the only real winners, leaving smaller institutions trying to liquidate their positions before the big hedge fund share holders like Richard Breeden find a quick exit strategy.
