Zale Corporation is a public company trading on the New York Stock Exchange (NYSE: ZLC). Through its wholly owned subsidiaries, it is still a leading specialty retailer of fine jewelry – diamond jewelry including - in North America. As of July 31, 2009, Zale operated 1,247 specialty retail jewelry stores and 684 kiosks located mainly in shopping malls throughout the United States, Canada and Puerto Rico. In view of the coming year-end sales season this corporation may well be a touchstone for the diamond market in the United States. Nicholas White, an analyst of Gerson Lehrman Group, shares his vision of this jewelry retail Goliath afoot for holiday trade.
"A new CEO at Zale, more of the same or is there something different this time? That is a good question, but one that is not easy to answer as the board announced Theo Kilion would become the company’s seventh CEO in ten years, but who is counting," writes diamond jewelry expert Nicholas White on http://www.glgroup.com. Mr. Killion, he says, was promoted to Interim CEO after Neil Goldberg resigned in January 2010. A human resource executive from the fashion apparel industry, Mr. Killion is now accountable for turning Zale around, while managing day-to-day operations too.
In addition, Richard Breeden has resigned from the Zale board along with his business partner John Cotter, leaving the company’s largest shareholder unrepresented. Zale’s new CEO, along with Kenneth Gillman, an outside financial executive, will immediately join Zale’s board. Earlier in the spring, Golden Gate Capital named Peter Morrow and Stefan Kaluzny to the board. Now, the company has four new directors and three old directors from the past, including Chairman John Lowe, who is slated to resign as of Zale’s 2010 Annual meeting.
Interestingly, the new board does not necessarily represent any shareholder block despite frequent reports that GGC is now Zale’s largest shareholder. Golden Gate Capital never exercised the warrants to buy up to 25% of Zale’s stock on a fully diluted basis. That is not surprising for several reasons. Until last week Zale stock was selling for under $2.00 per share, so why pay $2.00 for warrants for stock that is selling for a lot less, unless you expect the stock’s value to increase, which remains in doubt. The second reason, if Zale goes bankrupt, GGC would stand to lose in the neighborhood of $20 million as an equity stockholder and general creditor. However, standing back, GGC earns 15% interest on a $150 million secured loan plus hefty fees and has a front row seat to determine if there is any upside to this company. Longer term, the issue is how this new board will run Zale. Historically, Zale boards have micro managed the company. Given the current lineup, it would not be surprising if a hand on management style emerges again, especially given GGC’s deep reservoir of advisors.
Another issue is the lack of progress in driving the sales line, which is the primary reason the company was thrown into a liquidity crisis in January 2010. Despite the new CEO’s optimism that the business has improved organizationally and operationally, there is little evidence any of the changes will retard Zale’s chronic declining sales and profit trend. Granted, some categories are doing better than others according to Killion, but that is true in every business. Zale’s problem, now and in the past, is positive categories are growing much slower than in the competition’s store. Still, it appears Zale will focus more on diamonds this fall.
If in-store assortments and the website are the measure, Zale is likely to concentrate on Celebration Diamonds®, Shared Hearts®, Everlon®, basic merchandise, and selective deep discounting to pick up last year’s sales shortfall. Celebration Diamonds® was Zale’s response to Signet’s highly successful Leo™ Diamond Collection. Shared Heart® will face off against Kay’s Jane Seymour Open Heart®” collection, while Everlon® will be pitted against Signet’s own Loves Embrace® fashion diamond brand.
At first glance, Celebration Diamonds® appears well priced with entry-level prices starting around $495 for a 1/3 ct. total weight earrings. That compares to $410 for a similarly represented item from Blue Nile and Kay Jewelers for $695. However, a closer look may demonstrate Zale’s fundamental merchandising and positioning problems. For example, according to the company’s website, Zale’s minimum diamond weight for these earrings is .26ct (.07ct less than stated weight of 1/3 carat) compared to .31 ct for Blue Nile and .29 ct for Kay. Based on minimum weight criteria, that is about a 15% lower value per carat compared to Blue Nile and Kay as well as 16% and 10% less weight compared to Blue Nile and Kay jewelers respectively. In addition, Zale’s earring are set in a non-traditional, three prong mountings (pictured), but identified as four prong in the description, versus four prong mountings for Blue Nile/Kay earrings. Moreover, Zale’s earrings use friction backs, unlike the more expensive, upscale, screw back versions provided by both of the company’s competitors.
Remember this comparison is for one item carried by three competitors, picked at random and compared using information available on the company’s websites and the Internet. Accordingly, for this specific item, Blue Nile was the price/quality leader because of lower price, higher minimum weight standards, and mounting quality. Whether Kay or Zale is the better value for this item is problematic at best. However, consumers have been consistently voting for Zale’s competitors with their pocket books for the last half-decade and it remains to be seen if Zale’s new merchandising paradigm will change that trend, especially now that consumers are even more discerning and value conscious.
Everlon® is another likely product focus this fall. In part, the product is in the lineup because the brand is Zale’s competitive alternative to Kay’s Loves Embrace® collection and partly because Zale may benefit from DeBeers’ network T.V. spillover and co-op advertising. Still, the product hardly differentiates Zale from its core competitors as much as it associates the company with mainstream off price competition. For example, J. C. Penney currently offers Everlon® branded products at 50% off.
Shared Hearts® another likely fall focus is Zale’s in-house branded diamond offers that targets Signet’s Open Hearts® brand. The Jane Seymour inspired heart shaped jewelry collection is a market leader in celebrity branded fine jewelry, at least in the specialty jewelry segment. By that definition, Shared Hearts® misses the mark. Whether basic merchandise will match off to last year’s sales and pick up the shortfall remains to be seen.
The year-end conference call was unclear about the company’s fall strategy beyond a focus on core assortments. During the call, Killion said the core assortment had dropped to 60%, rising to 70% of total inventory. However, it is uncertain just what that means in terms of variety, breadth, and depth of the various product offers. For instance,
1. CFO Matt Appel said comparable store inventories would be flat with last season, but liquidity problems plagued deliveries last year, meaning planned inventory level were never achieved.
2. Last year’s planned inventories were below minimum inventory levels to support full assortments, which was one of the reasons for the sales decline. This year’s plan does not appear to address that problem.
3. With cumulative gold prices up 23% year over year, most recently closing at an all time high of $1,309.50/toz., only matching off to last year’s inventory levels means fewer units by definition.
4. The new CEO stated older good’s were not being priced at current replacement values, meaning next year’s assortments will have to be downsized materially given the wide difference in gold prices year over year, unless the company increases the amount of working capital invested in inventory.
Still, some analyst will point out Zale lost less money in FY 2010 than in the previous year, which for some suggests there is an end in sight. Of course, the issue is whether the cost cutting that improved P & L results for FY 2010 is 1) sustainable, 2) repeatable in FY 2011 and 3) will grow top line sales in light of the company’s continuing product and positioning issues.
