Plummeting Gold & Silver Costs Make Jewelers Compelling Buys
Brendan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Much ink has been spilled on the precipitous decline of precious metal prices. While investors have focused intently on companies that are exposed to these declines, they may have overlooked the beneficiaries of lower precious metal prices. One candidate: jewelers, who craft luxury items from precious metals and then sell them to consumers at a heathy mark up. It is likely that the declining cost of gold and silver may improve the margins of jewelry companies by reducing input costs, while the accelerating economy may coax consumers to purchase the luxury items they delayed buying until recently.
In mid-2011 and early 2012, jewelers significantly underperformed the market, as investors failed to anticipate the impact of high precious metal costs to the profitability of these companies. In 2010, gold and silver prices climbed 29.2% and 75.1%, respectively, and remained high for the entirety of 2011.
Unsurprisingly, the gross margin of Tiffany (NYSE: TIF) declined slightly in 2011, and then significantly in 2012, as these costs hurt the bottom-line. The figure below is excerpted from Tiffany's 2012 year-end report. A 2% gross margin decline may not sound like much, but this margin compression was enough to cause 2012 profits to decline to $3.25/share from $3.40/share even as revenues continued to grow.
Figure 1: The Impact of High Precious Metal Prices on Tiffany’s Gross Margin
Source: Tiffany's SEC filings.
At the present time the opposite scenario is unfolding. The price of gold and silver have declined 26.8% and 34.6%, respectively, this year to date. Because the prices of gold and silver have returned to where they were before the gross margin of Tiffany declined from 59.1% to 57.0%, it seems reasonable to believe that Tiffany and other jewelers may experience gross margin expansion over the near term.
Here are a few leading jewelers who stand to benefit from the declining prices of gold and silver.
Tiffany is an iconic American brand, established in 1837, that sells jewelry, watches, silver merchandise and a variety of other luxury consumer goods. The company has reportable segments in the Americas (48% of sales), Asia-Pacific (21%), Japan (17%) and Europe (11%). This diverse exposure, and the fact that Tiffany has not fully penetrated foreign markets, means there should be ample opportunity for growth going forward.
Tiffany trades for 23.6 times last year's earnings, with earnings growth averaging 6.3% annually over the past five years. While Tiffany has the strongest brand of any jeweler, it is difficult to argue that the company is cheaply valued at the moment.
Signet Jewelers (NYSE: SIG) is a specialty retail jeweler with sales in the United States, United Kingdom, and Ireland. The U.S. division consists of 1,318 stores located in malls and off-mall locations, under the names Kay Jewelers and Jared. Signet trades for 15.8 times last year's earnings, while earnings growth has averaged 11.5% annually over the past five years. Signet appears to be a very desirable combination of growth and value.
Zale (NYSE: ZLC) operates 1,124 jewelry stores in the United States, Canada and Puerto Rico. Likely due to its smaller size and economies of scale, the company has had a difficult time remaining profitable. Zale has not earned a profit since the great recession and revenue has shrunk by -5.2% annually.
As a result, Zale is the cheapest of these stocks at only 0.16 times last year's sales. Analysts expect the company to return to profitability, through a combination of improved margins and lowered costs.
On the most recent earnings call, Zale reported its first quarterly profit in five years. Management attributed its success to refinancing debt at lower rates, along with lower commodity costs, which drove:
"... Gross margin for the quarter of 52.6% compared to 51.3% for the prior year. The 130 basis-point improvement is primarily due to the relatively stable commodity cost environment that we have experienced over the last few quarters."
In other words, lowered commodity prices have already begun to improve the company's bottom line. As those costs continue to fall, Zale may continue to report improving profitability.
It is difficult to put a price tag on Tiffany's iconic brand. However, the reasonable valuation of Signet, combined with its ability to expand margins even during a challenging period of increasing precious metal costs, leads me to favor the latter.
Zale may provide the best returns, since expectations are so low due to the poor performance of the company. However, Zale appears too risky for exactly the same reason, and I prefer to place my bet on the company that has performed the best over the past several years.
It is likely that the gross margin of Signet would have increased even more if gold and silver prices were low. As a result, continued margin expansion seems quite likely at the present time. Combine this with continued revenue growth, and Signet's outperformance relative to the market seems likely to continue over the next year or two.
Brendan O'Boyle has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!