Summary
Zale promises to finally announce year end results. Meanwhile the stock continues to increase in price,despite likely big losses. Here's why.
Analysis
Zale’s stock price has continued to climb despite the announcement that accounting irregularities discovered during the most recent audit meant past year’s earnings would have to be restated and the year end annual report delayed until October 29, 2009.
Most analysts expect Zale to post a huge loss for FY2009. The losses are in part the result of decreased margin and sales during the Christmas 2008 quarter, but also because of charges to earnings from cost cutting measures like reducing staff and closing stores. However, estimating Zale’s FY 2009 sales and earnings is nearly impossible since as of the end of October, it will have been six months since Zale reported any sales or profit numbers whatsoever. Any projection would have to be a guess, since there is nothing current to base any rational estimate on. Still, the stock price has continued to increase. Since July 1, Zale’s stock price has increased from $3.33 to $7.06 as of its close on October 23, 2009. That’s about a 112% increase.
What’s driving the increase? Speculation is certainly one factor. However, some large funds have bought into the idea the company is either on the verge of turnaround or that overall better fourth quarter retail sales performance will likely raise all retailer’s performance higher, including Zale. As ironic as it sounds, that kind of logic has driven Zale’s stock price higher in three of the last four years before Christmas, only to have the price significantly decline by the end of the December. In fact, since 2005, Zale’s stock price has declined on average 28.9% by the end of December from it price at the beginning of August. Only in 2006, did Zale’s stock close higher after Christmas.
What does this year have in common with three of the four preceding years? Well for one thing, the company’s still in turn around mode. Better put, it still is trying to get into turn around mode. It’s this promise, all be it an empty one thus far, that motivates existing and prospective investors to push the stock price higher each fall. But, it’s management’s repeated failure to deliver meaningful change that has minimized results, driving the stock down after Christmas.
Whether the rising tide theory applies today also remains to be seen. Granted, a variety of big box retailers have seen a modest improvement in sales since September, but whether the same applies to luxury products like fine jewelry remains to be seen. Given that Zale’s year end statements won’t be released until the end of October and the timing of the release of its first quarter results probably will be scheduled for just before Thanksgiving, investors won’t have much information about performance until late in the game. Add that Thanksgiving hasn’t been as late in the year since 2003, meaning investors won’t know much more at the end of November.
Investing in Zale this year shapes up to be even a bigger crapshoot than in previous years. For instance, the company is up against low margins last year that resulted in about a 16% decline in sales. As of the third quarter, the company had recovered its historical margin rate of about 50.1%, but at a cost of nearly a 20% decline in sales. That was against previous years sales at a 47.5% margin rate.
Now Zale is up against 43% margin rates. The plan, achieve approximately 3rd quarter, FY 2009 margin, which translates into selling the same product that sold for about $875 last year for $1,000 this Christmas. Frankly, that rationale seems ridiculous in the face of higher unemployment (higher than last year), reduced consumer credit, declining wage rates, and higher gold prices too.
Nevertheless, that was pretty much the strategy in place as of the 3rd quarter, at least according to Zale’s official comments. Still, how it worked in the 4th quarter of FY2009 and the 1st quarter of FY 2010 (ending October 31) is anybodies guess. Moreover, jewelry industry analysts say that average selling prices have decreased about 10% through the end of August. If that industry average applies to Zale, it’s facing the consequences of both declining transactions because of higher margins and decreased selling prices too. While, you can play with the mathematics all day, about the only reasonable conclusion anyone can draw about the whole strategy is its more arithmetic than substance. That is unless the jewelry category got a huge uplift after September 15, 2009. That’s about when the industry would have started to calendarize last year’s massive sales declines.
However, that doesn’t seem to have happened. Specialty jewelry sales were down 10.6% in August, slightly better than the category’s 11.6 decline year to date. Mall figures show jewelers there increased sales about 1.2% in September, but there is some question whether changes in the timing of the beginning the school year pushed traffic from August to September, making those comparatives less meaningful. Clearly, there’s no indication that sales are rebounding to 2007 levels. In contrast, its seems more likely once predictable consumer spending patterns have been replaced by periodic “spurts and fits” such that it’d doubtful whether one week’s actual sales are a reliable predictor of next week’s sales or next months sales for that matter.
Nicholas White consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
