Michael O’Hara, Chief Executive Officer of Consensus Advisors, a boutique investment banking and financial advisory firm based in Boston, in his analysis of this year’s American jewelry market posted by the National Jeweler Magazine writes about possible developments in the U.S. jewelry industry.
“The best investment bankers excel at two things: observation and interpolation, which together yield the ability to make predictions. I am flattered that National Jeweler asked me to predict the most influential trends impacting the U.S. jewelry industry in 2010, relieved that I was able to do so after the first 90 days of the year and pleased to have tapped into the opinions of a number of insightful jewelry industry colleagues and friends,” he says.
Here are the trends we think are worth watching:
1. Zale Corp. Rarely is a single company a trend, but an exception must be made when said company - the largest U.S. jewelry chain in 2006 - becomes the subject of daily media reports suggesting its impending demise.
The loss of Zale would deal a major blow to many in the diamond and jewelry supply chain, and present a major opportunity for retailers competing in the cutthroat middle market, such as Sterling Jewelers’ Kay Jewelers, Kroger’s Fred Meyer Jewelers and Berkshire Hathaway’s Helzberg Diamonds. We don’t see Zale filing bankruptcy, however, and we certainly do not see it liquidating (at least not in the first half of 2010). Look for major stockholder Breeden Capital to drive the company towards a capital infusion, most likely from the financial industry, that may be coupled with one or more divestitures.
If structured correctly, any such transaction will enable Zale’s new management team to be bold through the 2010 holiday season without the threat of bankruptcy hanging over their heads. Since Zale has been slow to replace its top three operating executives who left the company in January, look for a transaction with a group that brings active management to the table.
2. The Consumer. The 2005-2007 era is not coming back, and the consumer is getting used to the new world and recognizes that the party is over. Americans who lived through the Great Depression carried it with them throughout the remainder of their lives. Expect that the wake-up call we have all experienced during this recession will resonate with the consumer long after any technical macroeconomic recovery. Credit will be less free-flowing and it will be used more carefully. Discretionary purchases - and, except for bridal, jewelry is perhaps the most discretionary purchase there is - will be low priorities for the rest of 2010.
3. Diamond and Gold Prices. Make no mistake, investors worldwide are worried about the U.S. deficit and our currency. Globally, there are serious questions being raised about our system of capitalism and our government’s ability to make needed structural repairs. It is no secret that gold has emerged as a hedge against inflation risk, but also against investments in U.S. dollars.
This speculative force has kept gold prices higher than the industrial demand would. My colleague, Chris Ellis, has elsewhere made the provocative point that, in the absence of speculation and hedging, gold prices could actually collapse in 2010 as there was a historic amount of secondary-market gold pushed back into refineries in 2009, coupled with a broad-based decrease in demand. So here’s the bold prediction: Gold prices will not be driven by jewelry manufacturing demand in 2010.
The diamond market is more straightforward. The recession caused the big mining companies to reconsider the economics of running mines full time, resulting in what appears to be shortages of rough and polished diamonds in some key categories. This shortage comes at a time when the global demand is stabilizing and, in some parts of the world, growing. Polished diamond prices may also be driven up by speculative interest as they, too, can serve as a hedge against inflation. It appears certain that diamond prices will rise in 2010.
4. The Return of Bank Lending. After 16 months of utter turmoil, it seems commercial banks are lending again. Assuredly, interest rates are up for borrowers and advance rates are down as compared to the salad days of 2005-2007, as both reflect the more risk-averse approach of banks in the wake of the Lehman Brothers collapse. Retail borrowers will find interest from community and regional banks (note NewAlliance’s loan to Hannoush Jewelers, for example) that will likely benefit from President Obama’s directive to shift repaid Troubled Asset Relief Program (TARP) money their way. Wholesalers and manufacturers will benefit from new leadership at ABN AMRO and Standard Chartered, as well as from reinvigorated stalwarts such as HSBC and Bank Leumi.
5. Bead Jewelry Systems. When Crocs first came out, our position was that they were not going to change the footwear world, but they weren’t a flash in the pan, either. We thought of Crocs as a new category: something between a flip-flop and a sneaker. This may also be true of bead systems: They are something to fill the gap between fine jewelry and costume. Pandora, Chamilia and the like have introduced collectible, personalized jewelry that encourages repeat customers. This connection with the customer and the category’s attractive margins make bead systems a savior for retailers in a tough economy. Interest in these products will not wane in 2010. The heat from the fad may eventually cool, but we see no reason why this isn’t also a new jewelry category for the long term.
6. Online Selling/ Reduction of Store Counts. Store-level inventory continues to be the bugaboo of the jewelry industry. Simply put: jewelry is small and expensive, and stores need to be big enough for people to walk through an assortment. Therefore, jewelry stores will almost always have more inventory investment than any other retail category. This can be combated by eliminating marginal stores and enhancing one’s Internet business. Blue Nile has shown that this is possible, and others will adopt this approach to improve their asset utilization.
7. Private Sales. Private sale retail Web sites such as Gilt Groupe, Rue La La and Portero are all the rage in retail so far in 2010. These businesses communicate directly to a limited group of in-the- know consumers who are invited to participate in short-term offerings, typically of branded merchandise. These businesses thrive due to the loyalty and enthusiasm of their Internet-savvy customer base. This method of selling is unique in that one’s own customers become the retailer’s sales force. Mastering this channel should be on each jeweler’s 2010 to-do list.
8. Vintage and Estate Jewelry As consumers deal with less discretionary spending, they are increasingly selling their old merchandise into the secondary market. This is a good source of cash for customers who may then use the funds to buy newer goods. Retailers will embrace this secondary market in 2010 to facilitate trade-ins and upgrades. Look for secondary market leader Circa to enhance its partnerships with retailers in 2010. Also look for authenticated luxury marketplace Portero to increase its reach with consumers and small retailers by providing an outlet to sell their used goods to consumers directly online.
9. Brands Loosening and Tightening Watch for mixed messages from jewelry brands in 2010. Companies such as Cartier will look to restrict the breadth of their distribution and focus on self-branded boutiques, while others will loosen the historically difficult trade credit terms they demand from retailers.
10. Emergence of Important New Brands Retailers more than ever want non-risky, fast-selling products on their shelves. Product with strong branding and marketing efforts behind it will be important, as will innovative product from exciting designers. Look for retailers and manufacturers to try to capture some of the momentum that Pandora, David Yurman and John Hardy bring to the table through innovative design and broad consumer marketing. Our firm, for example, just served as the agent for a license agreement between a major sightholder and a British fashion icon for a new line of distinctive diamond jewelry.
11. Consolidation for Survival’s Sake Jewelry is a slow-turning, highly fragmented and super-competitive industry. Because of this, it is uniquely leveraged among retail and consumer categories. This is often a formula for consolidation, but we now believe that critical forces for consolidation are lacking. Private equity and hedge fund investors—often the catalysts for consolidation—have floundered in their investments in the retail jewelry space.
Additionally, while we see commercial lenders coming back to the table in jewelry, we do not see them offering the types of turns on debt that entice financial players to rush into acquisitions.
If consolidation will occur in 2010, it may well be undertaken to facilitate survival. For instance, two companies may merge in order to reduce expenses and gain pricing power to maintain a positive cash-flow position. One example is Berkshire Hathaway’s Richline Group, which has proved to be an able consolidator of jewelry businesses that should survive with a streamlined overhead. To the extent that there are major acquisitions, we expect them to occur between peers.
