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Can Jewelry Retailers Add Luster To Your Portfolio?

By Brian Hill - Feb 8, 2014 at 7:00AM

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Jewelry retailers such as Zale Corporation, Tiffany & Co., and Blue Nile are seeing a much improved, but still challenging, sales environment as consumers remain cautious with discretionary expenditures.

Jewelry can be viewed as a luxury good for affluent consumers, a fashion accessory, and also a necessity in the case of wedding rings. During the recession, jewelry was one of the many classes of products that consumers cut back on purchasing. Today we look at recent results for Zale Corporation (NYSE: ZLC), Tiffany & Co. (TIF), and Blue Nile (NILE) to see if the improving economy has rewarded these companies.

The best (quarter) is yet to come
Zale is a specialty retailer of diamond and other jewelry products that serves the North American market. The company has nearly 1,700 retail locations. Its brands include Zales Jewelers, Zales Outlet, Gordon's Jewelers, and Peoples Jewelers.

In late November, Zale reported its first fiscal quarter results for the period ending Oct. 31. Total revenue increased by just 1.4% from the same quarter of 2012 to $363 million. Comparable-store sales increased 4.4%.  

Gross margin percentage rose 20 basis points and the company was able to reduce selling, general, and administrative expense as a percentage of revenue by 40 basis points. Zale incurred an operating loss of $22.0 million for the quarter, which was a 4% improvement over the year-over-year result in 2012.

Because holiday sales are so critical to retailers, Zale is one of the companies that provides an update before reporting the next quarter's results. For the combined months of November and December, comparable-store sales rose 2% from the same period last year.

CEO Theo Killion described this as a "challenging retail environment." The company's improved gross margin partly came as a result of Zale focusing on its exclusive products. The company also updated its outlook for the quarter ending Jan. 31, saying it expects gross margin improvement of 200 basis points over the same quarter last year with an operating margin of 8.6%, which would be an improvement of 100 basis points.

So the important takeaway isn't the loss in the first fiscal quarter -- when operating margin was a negative 6.1% -- but the good upcoming results in the second quarter. For last year's second quarter, the company reported operating income of $51.3 million.   

Sparkling double-digit sales growth
Blue Nile has a completely different retail strategy than Zale -- it has become the leading online retailer of diamonds and fine jewelry. For Blue Nile's third quarter ending Sept. 29, net sales were up appreciably -- 10.1% from the same quarter last year to nearly $100 million.  

This standout quarter was the sixth consecutive quarter in which the company grew sales by a double-digit percentage. 

Gross profit percentage increased a bit, 10 basis points, but selling, general, and administrative expenses were $1.9 million higher, which caused operating income to drop just over 5% from the same period last year. However, a $1.3 million positive swing in income tax expense caused the bottom line to look very good. Net income was $2.9 million versus $1.7 million last year.

Exporting an American brand name synonymous with quality
Tiffany & Co.'s fine jewelry merchandise brought in 90% of the company's net sales in 2012, but crystal, sterling silverware, and timepieces are also components of its merchandise mix. Tiffany stores are located across the globe and its brand is gaining popularity in the Asia-Pacific region, Japan, and Europe. At the end of the third quarter, nearly 58% of the company's stores were located outside the Americas.

For the third quarter ending Oct. 31, worldwide sales for Tiffany were up 7% over the same quarter in 2012. The best performing region was Asia-Pacific, where sales increased 27%. In the Americas, sales rose 4%.

The positive effect of higher sales on the company's bottom line was accentuated by a 260 basis point increase in gross margin percentage, as product costs declined and price increases from earlier in the year kicked in. Selling, general, and administrative expenses as a percentage of net sales were also favorable, down 60 basis points from the third quarter of last year.

As a result of this excellent operating performance, Tiffany's net earnings soared 50% to $95 million -- a net profit margin on sales of more than 10%.    

What we learned
Zale has been able to achieve positive same-store sales for 12 quarters in a row. A perspective on this company's large scope is that it had more than $900 million in merchandise inventories on its balance sheet at the end of the quarter.

Zale presented at the ICR XChange conference in January. Management discussed the dramatic turnaround in the company's performance between 2010 and 2013, when the company reached profitability -- although with modest net earnings of $10 million -- for the first full year since 2008.

Zale accomplished the turnaround by focusing on increasing same-store sales, building its omni-channel platform to accommodate customers' desire to shop outside the store environment, and increasing the percentage of higher-margin exclusive product offerings in its mix. The company also closed underperforming stores.

Blue Nile has been working on its technology platform to enhance the user experience, whether customers are ordering from their PC, tablet device, or phone. This company's fabulous pace of revenue growth indicates that consumers are comfortable with ordering emotionally important items such as rings through digital platforms instead of visiting retail stores.

Although Blue Nile benefits from not having to invest in retail space, it must continue to provide outstanding customer service that replaces the visual and sensory experience of purchasing in a store. The company's motto on its website shows this focus: "Education. Guidance. Diamonds and Fine Jewelry." Notice that education gets top billing.  

So which of these companies is the true gem for investors?
As heroic as Zale's turnaround has been, I like Tiffany & Co and Blue Nile.

Tiffany & Co.'s ability to continue developing its brand presence outside of the U.S. should mean continued revenue growth. Also, a profit margin on sales of 10% for a retailer is quite spectacular. Meanwhile, Blue Nile's innovative business model has proven itself to be a winner with customers.

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