Summary
Zale hastily closes 118 stores in the 4th quarter. But, is it panic or a part of plan? Here's more.
Analysis
Zale announced it had closed and additional 118 stores in the 4th quarter. That’s in addition to the 73 stores closed during the previous three quarters. According to the company, these stores collectively lost about $14 million in the preceding 12 months prior to their closure. It’s a common practice for retailers to close underperforming stores. Usually, management minimizes cost by closing the stores as leases expire. However, that isn’t the case this time. According to the market, the company finally made the decision to close them in the 3rd quarter, a quarter in which Zale reported much larger than expected losses. Clearly, the company put on a full court press to get them closed during the fourth quarter, which begs the question, if they were such bad performers, why did Zale wait so long.
Wait and see appears to be the strategy of the hour at Zale, followed by a “just do it…NOW” implementation tactic. The organization has to be near burnout, especially with all the downsizing. Again, if all those jobs were non-essential, why was the company burning cash to keep the people employed a year or so earlier. Frankly, many of them probably were necessary for the smooth functioning of the organization. Down sizing, almost by definition, doesn’t mean reengineering the work process to achieve a lower cost structure. Rather, it means either fewer people do more work or things aren’t done. Eventually, it leads to burnout, poor planning, and even poorer execution. Everything is a fire drill.
Zale estimates the closures will result in a $50 million charge to FY 2009 earnings. That number includes the cost to settle the company’s contingent liability for 35 Bailey Banks and Biddle leases that it had guaranteed as a part of the BB & B sale to Finlay Jewelers in 2007. Finlay filed bankruptcy on August 6, 2009, so the remaining BB & B lease liability of $29 million will probably hit the 1st quarter 2010 P & L.
Another point, Zale has been silent about how it’s realigning the company’s real estate portfolio. At issue are the long-term consequences to the company’s returns as it makes deals to close all these stores and settle BB & B contingent liabilities. Developers don’t reduce future lease payments for nothing. Granted, mall property owners have recognized the need to adjust occupancy costs in view of the recession, but Zale’s real estate issues are more pervasive. Not only has Zale wanted to adjust rental costs for on-going leases, it has had to negotiate settlement s for closing stores, contingent liabilities, all the while reducing the total amount of sales space leased from developers. That isn’t a position of strength, which may mean there is a long-term cost implication for the company when it reenters the real estate market as a net buyer of selling space.
Lastly, Zale ends up with another traunch of inventory that it either has to hold until it’s needed or sold off at a discount. Estimated to be about $54 million, the company didn’t say whether it had made a specific provision for liquidating the excess inventory during FY 2010.
Moving forward, it’s hard to see how this current effort to turn Zale around has a happy ending. The company starts FY 2010 in the hole by $29 million, offset in part by the $14 million reduction inlosses from the previous year’s store closures. The previous year’s HO cost savings will absorb the remaining $15 million, that’s just a guess. But, no matter the point is there isn’t a big win on the cost savings side that investors can count on for incremental earnings. Unfortunately, there will probably be another 100 or so stores losing money after Christmas if the last 24 months trend is the measure and another store closure program also.
It's hard to see any plan underlying the company's direction. At best, it appears to be a reaction to another set of unrealistic "hoped for"; at worst, its indecision coupled with panic, which will destroy the companies "will to win" and shareholder value too. The fact is circumstances are very different this year. Many jewelry companies are literally fighting for their various existences. In short, this is a market share management Christmas where the winners will be those jewelry retailers that can successfully steal sales from their local competitors using a combination of product, price, and service, areas where Zale has shown historic weakness and little improvement to date.
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.
