Whitehall Jeweler's Liquidation Illustrates the Need for Industry Change

Implications: Whitehall's liquidation sale will have significant consequences for publicly traded jewelers like Kay, Zale, and Finlay not only this fall, but in future quarters also.  Here's why. 

Analysis: About three quarters of a billion dollars at retail in fine jewelry and watches will be sold at near cost as consumers begin shopping for Christmas.  The sale organized by several liquidators will be a combination of products from Whitehall’s 375 stores that are being closed and jewelry items from the liquidators own inventory.  The sell off is the second large going out of business sale this year.  Earlier, Friedman and Crescent Jewelers stores were closed and about $400 million in inventory at retail was liquidated. That blowout continues even as Whitehall starts their going out of business sale.  

Whitehall’s inventory clearance binge comes at a particularly bad time for jewelry competitors as early Christmas shoppers enter the marketplace.  Research has shown that jewelry shopping behavior is often a lengthy process, particularly for high value, infrequently purchased items like diamonds and fine jewelry. About 15% of eventual Christmas jeweler buyers either buy or make their purchase decisions in August, with another 30% making their choices by the end of October.  Add, year long clearance sales by the likes of Zale have also cannibalized some 2nd half sales and you have a difficult selling environment made more hostile as Whitehall goes out of business.  

Just what effect these inventory clearance sales will have on the 2nd half’s jewelry business isn’t clear.  Terry Burman, Group CEO of Signet Group Plc, commented that Zale’s clearance of about $200 million in retail inventory may have cost Kay and Jared brands one or two percentage points in growth.  Then Signet had reported its same store sales had declined about (5.8%) in the 2nd fiscal quarter.  Whitehall’s inventory liquidation is nearly twice as large as Friedman’s and four times that of Zale’s inventory reduction.  Moreover, it comes during the critical Christmas selling period where most jewelers earn more than 90% of their profit.  

The jewelry competitors that will be the most in jeopardy are mall based jewelers in the 39 states where Whitehall was located.  About one-half of those locations are in California, Florida, Texas, Georgia, Illinois, and North Carolina.  Clearly mega chains like Kay and Zale will lose sales, as will smaller chains like Fred Meyer (Kroger Inc.) and Helzberg Jewelers (Berkshire Hathaway) which also operate in most of Whitehall’s markets.  Off mall chains like Jared’s Galleria of Jewelry, Birks & Mayors, Congress (Finlay), and better independents will be partially insulated from the Whitehall’s jewelry blowout, especially those carrying branded jewelry, gift, and watches.  Evidently, about a third of the inventory will be remnants from the liquidator’s past sales.  Still, even shop worn, picked over jewelry will be appealing to bargain conscious shoppers when sold at half price or more.  

Some of the consequences of the Whitehall’s sell off may come before the end of the 4th quarter.  For instance, ‘credit jewelers’ already suffering from the effects of reduced liquidity may find Whitehall’s clearance sale their breaking point; forcing them to close and liquidate too.  Likewise, large jewelry businesses like Finlay Enterprises, already suffering from too much debt and declining market share, could find vendor financing difficult to secure this fall.   

Finlay operates about 687 jewelry departments for department store chains like Macys, Bon-Ton, and Dillard’s.  In addition, the company also owns approximately 105 fine specialty jewelry stores under the Carlyle, Congress, and Bailey, Banks, and Biddle brands.  Earlier this year, Finlay’s credit rating was lowered to that of junk quality meaning the company’s liquidity depended in large part on a strong economy.  Most recently, Finlay announced its 2nd quarter like for like sales had declined about (5.0%).  

The company is scheduled to announce its 2nd quarter earnings on August 27th; in the meantime, a cursory sales review suggests average sales per store for Whitehall’s specialty stores have declined.  That could mean growth in its fine jewelry stores has slowed, the integration of BB & B is off-track, or both.  Regardless, the results are bad news of Finlay investors and even worse news if the likely effect of Whitehall’s liquidation is factored into the company’s sales plans for the fall.  

There are beneficiaries of these deep discount sales, for example, secured creditors and jewelry suppliers.  Consumers will benefit also.  Despite spending cutting backs, US jewelry sales have held up particularly well during this economic downturn.  According to the latest figures, total jewelry sales increased 3.1%, 5.1%, and 5.9% for February, March, and April 2008 respectively.  That’s significantly better than general merchandise sales growth for March and April.  Unfortunately for investors, publicly traded jewelers have performed worse than both the retail industry in general and specialty jewelers specifically. 

For the year some industry analysts expect sales to increase about 3%.  Part of that increase will come from jewelry price inflation, but some will also come from customers buying jewelry during these sales that they otherwise wouldn’t have bought.  Current trends indicate most of the large publicly traded jewelry chains, like Zale, Signet Group, and Finlay will not only continue to lose market share to discounters, better independents, and small chain jewelers, but will likely lose a disproportionate share of market because of liquidator’s sales too.  

Eventually, the economy will improve and precious metal prices will stabilize; all be it at a much higher levels than in the previous decade.  However, it would be a mistake to think that large jewelry store chain’s sales growth will necessarily return to pre-slowdown levels.  There are several reasons why.  First the competitive structure in the industry will have permanently changed.  It’s likely there will be more bankruptcies by jewelry manufacturers, wholesalers, and retailers alike, some probably before Christmas.  Second, consumer behavior has changed because of credit crisis and higher energy prices.  Third, large and mid-sized specialty jewelry chains, as well as, lease jewelry operators will have lost much of their original competitive advantage, including their margin gain from selling diamonds, cost leverage from superior IT infrastructure, and position benefits from dominant mall locations.  

Combined, predatory bankruptcy reform, reduced consumer liquidity, fragmentation of the diamond pipeline, declining cost of back office and POS software, and reduced efficacy of the mall as a shopping destination will force both jewelry retailers and manufacturers to restructure.  Fortunately for the industry, consumer attitudes are in flux making change more palatable if not expected and many of the retail, technology, and supply side components necessary exist.  The big question for investors is who will put it together first.