Zale Continues Its Turnaround
Alan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Zale Corporation (NYSE: ZLC) delivered a solid performance for the second quarter and first half of its fiscal year ending Jan. 31. Second quarter EPS was $1.02 and first half EPS was $0.32. The comparisons for the same periods last year were $0.77 for the quarter and $0.09 loss for the half. Management reaffirmed that the company will return to profitability for the entire year ending Jan. 31, 2014.
Zale’s performance for the second quarter and first half
There were no surprises. Management adhered to the initial three-year plan given to shareholders. Analysts’ consensus projection is $0.12 per-share for the full year, as compared to a loss per share of $0.84 last year.
Management continued to re-evaluate individual store profitability as circumstances, such as lease expirations, allowed. It's my impression that they will continue this process, but the major house cleaning is nearing completion.
Same store sales for the quarter and half were 2.8% and 3.2%, respectively. Though, lower than last year’s comps, it was the ninth straight quarter of positive comps for the company. Previous comps were partially driven by the steady elimination of underperforming stores in recent years. Zales, Zales Outlet and Vera Wang had substantially better comps than the balance of the other brands. Gross margins for the quarter and the half were 50.6% and 51.5%, respectively. The comparable figures for last year were 50.5% and 51.6%. Operating margins for the quarter and half were 7.6% and 2.7%, as compared to 6.5% and 2.0% last year. Increased emphasis has been placed on social media and the web to drive sales. This marketing effort will continue into this year.
The restructuring of the company’s debt reduced interest expense by approximately $10 million for the first half and $4 million for the second quarter. It's also noteworthy that CalPERS bought out the balance of the Breeden interest of about five million shares. Breeden was an active seller last year and constituted a large overhang of stock. Breeden was also closely identified with the bad old days. CalPERS represents a strong and patient holder.
The near term future
I believe that a full turnaround and the beginning of significant new investments can be made in growth over a two to four year period. However, some major improvements can begin to happen from now through 2013 and in to 2014. There's no anticipation of any expansion of fine jewelry stores in the next year, and there might be some pruning in stores, particularly in the Gordon’s division.
Given the continuing limited amount of money available for expansion, the company will emphasize growing the top line in its U.S. businesses through improvements in sales staff, increasing the SKUS in its proprietary offerings, as well as increasing the number of stores carrying them. There's a good chance they will add another proprietary line. Paramount, of course, will be emphasizing the identification of its U.S. Zales fine jewelry business as The Diamond Store.
Web sales will continue to grow. A new and already successful strategy has been developed, allowing customers to have higher priced jewelry shipped to a store close to the customer for a hands-on evaluation before a final purchase is made. This creates direct contact with sales representatives in a store environment. It has been a successful strategy because it gives the sales reps a better opportunity to close the sale, or if necessary, advise the customer in finding an alternative product. With the customer in the store, other merchandise can be offered to increase gross sales. Very important related sales, such as insurance, lifetime warranties and credit cards, can be offered, which greatly enhance the value of the sale.
During the past three years, the company experienced head winds in the cost of raw materials. That placed pressure on maintaining margins. Now that costs have stabilized, management sees opportunity for manufacturing more of its own product. With a stronger balance sheet, it's in a position to begin bargaining with its vendors for better prices or money-saving services. Management believes it can significantly improve results for Kiosk, Gordon’s and their Canadian jewelry business.
Last, but not least, there will be a sharp drop in interest expense owing to the recent renegotiation of the Zale debt. Additional small cost decreases should include depreciation and internal labor expended on cost reorganization.
Consensus analysts’ projections for fiscal year-end Jan. 2014 are an EPS of $0.40. In my projection, I've separated the company into two segments: The first group includes Zales, Zales Outlet and proprietary products such as Vera Wang. The second group includes Kiosk, Gordon’s and the Canadian jewelry business. With respect to the Zales product group, I project 4-5% sales growth and a combined margin improvement of 4%, including higher gross margins and greater sales leverage. For the balance of the divisions, I have held them essentially even with last year. I don't believe they will be negative, but I am not prepared to project them. I believe they won't have much impact this year. My projection for the year is an EPS of $0.45.
Positive surprise factors
- Faster growth in sales and profit possibilities for Kiosk and Canadian division
- Early introduction of additional proprietary product
Negative surprise factors
- Sharp downturn in middle-class consumer spending
- Difficult competition from Signet, which has just entered outlet business
I continue to believe the stock is a strong speculative buy.
Zale’s competitors and their possible effects
Blue Nile (NASDAQ: NILE)
The company is the second largest online seller of diamond jewelry behind Amazon. Its goal has been to be the low-cost seller of high quality diamond jewelry. To accomplish this, the company has put its energy into designing a website that allows a customer a limited selection of styles, a fine selection of diamonds and a wealth of information. The buying process is not easy and not suitable for everyone. However, I understand both the products and prices are attractive. Over the past decade, the company has continued to grow at a good rate but has never shown the capacity to reach breakout velocity. For the past three years, volume has shown good growth while profits have stagnated. The company does only $400 million in sales currently and shows no indication of being able to be a significant player in the industry. The company also repurchased about $80 million of its own stock in the past two years at relatively high prices.
The stock sells for a PE of 42 times this year’s projected earnings. It will take years of substantial growth to justify its current valuation. While its price is down considerably from its high, the stock is definitely a sell.
Signet Jewelers Limited (NYSE: SIG)
Signet is the prime name among U.S. fine jewelry retailers. It's also the largest jewelry retailer in the U.K. The U.S. is, by far, its largest market, accounting for over 85% of sales. It trades under a variety of names in the U.S. The two most important, by far, are Jared and Kay Jewelers. With sales that should approach $4.2 billion this year, and a net worth in excess of $2.5 billion, the stock is selling at about 12 times projected earnings and has a current yield of 0.8%. Moderate internal growth and an occasional acquisition, such as its recent purchase of Ultra Stores, a chain of outlet stores similar to Zales Outlet Stores, should provide the conservative equity investor a reasonable long-term rate of return. I would rate the stock, at minimum, a hold and possibly even a buy.
Alan Ginsberg has no position in any stocks mentioned. The Motley Fool recommends Blue Nile. 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!