Sterling Jewelers, the U.S. division of Signet Group, proved once again that it is at the leading edge of jewelry retailing in America. U.S. sales were $2.56 billion, up nearly 1 percent in a tough environment where industry sales fell by nearly 2 percent.

 

Not only did its fourth quarter and full year results exceed expectations, but the company has taken bold steps to boost its sales and profits, including the following:

 

·        Between February 15 and March 15, Sterling raised retail prices on about 30 percent of its line – mostly items with a heavy gold content. As far as we can tell, there has been no significant customer push-back from this move.

 

·        Sterling typically spends about 7 percent of sales on advertising; this is well above the industry average of about 4 percent. Thus, it is no surprise that Kay Jewelers – and its highly memorable tagline “Every Kiss Begins With Kay” – has top-of-mind recognition with shoppers.

 

·        Differentiated merchandise accounts for up to 30 percent of Sterling’s sales. Today’s customers want “something different,” and Sterling is meeting their needs.

 

·        Net store space reductions were more modest than we had anticipated. Further, the company’s acquisition policy is unchanged, despite contrary reports in the mass media. Thus, the company has ample retail outlets in a wide variety of locations to serve customers “where they are.”

 

Sterling Picked Up Market Share in 2009

Here are the key sales metrics from Sterling Jewelers’ full fiscal year ended January 2010 versus both the prior year as well as versus industry metrics. As is clear from the sales figures, Sterling Jewelers gained market share in the U.S. during 2009, both from other specialty jewelers as well as from the total jewelry market including discounters, online sellers and all other merchants selling jewelry.

 

 

Corporate Financials Improve

Sterling Jewelers’ financial results also showed improvement for its fiscal year ended January 2010, as the following table illustrates. Its operating margin rose, and the company’s merchandise gross margin was up for the year by 0.4 percent (40 basis points). In addition, the total corporate entity – Signet Jewelers which includes both the U.S. and U.K. operations – posted a higher gross margin, a lower operating expense ratio, and an increase in its profit margin, even after eliminating unusual expenses in the prior year.

 

 

Sterling’s merchandise margin was driven by several factors, including modest mix changes, better deals from suppliers, prices, and a variety of other efficiencies.

 

It is important to note this: because Sterling has solid financials, its vendors do not need to buy credit insurance on their receivables from the company. Further, because it has ample cash (it paid down debt by almost $250 million in 2009), it is able to get attractive “early settlement” discounts from vendors. This helps bring down its cost of goods.

 

Underlying U.S. Division Sales Shows Disparity

During 2009, Sterling’s Kay Jewelers stores were the stellar performers. Its regional brands posted disappointing results, and financials from its upscale Jared stores lagged. The weakness at Jared is no surprise, since demand for higher-end jewelry was weaker than demand at the mass market level in 2009. The following table summarizes sales results by Sterling’s retail divisions in the U.S. for the full fiscal year.

 

Brand     Sales $ Mil     Sales % Chg Y/Y Same-Store Sales % Chg Y/Y Average Unit Selling Price Avg Unit Selling Price % Chg Y/Y Kay $1,508.2 4.8% 4.4% $307 (7.4%) Regionals $326.8 (11.9%) (4.0%) $329 (4.8%) Jared (1) $722.5 (0.5%) (6.0%) $713 (7.3%) Total U.S. $2,557.5 0.8% 0.2% $324 (16.8%) (1) Jared average selling price excludes the charm bracelet category

 

Other Financial Metrics Show Some Change During the Year

·        While Sterling typically spends about 7 percent of sales on advertising, prior to co-op and other rebates, its ad spending as a percentage of sales declined to near 6 percent in 2009 because sales were stronger than planned. This helped boost bottom-line profits.

 

·        Sterling’s credit operations helped it maintain sales momentum in 2009, though management claims that it did not increase the risk profile of its credit portfolio. Key metrics from the in-house credit operation include the following:

 

o       Credit participation rose modestly to 53.5 percent from last year’s 53.2 percent.

 

o       Net bad debt as a percentage of total sales rose to 5.6 percent from last year’s 4.9 percent.

 

o       Net bad debt as a percentage of total credit sales rose to 10.4 percent from last year’s 9.2 percent.

 

o       The monthly collection rate fell to 12.5 percent versus 13.1 percent for fiscal year 2008.

 

o       The credit maturity remains around eight months, despite a slight decline in the monthly collection rate.

 

o       Credit application acceptance rates rose modestly after the company adjusted its criteria for some applicants, based on their historical payment performance. Management was adamant: “This did not reflect a change in the risk profile from which the credit operations are managed . . . .”

As a result, the approval rate on credit applications increased by 210 basis points, but still remains 90 basis points below the level of fiscal 2008.

Management noted that there was some stabilization in the credit portfolio during the fourth quarter of 2009.

 

o       Management also noted that the efficiencies of operating an in-house credit operation became more apparent during the recent recession. Banks who provided third-party credit became more choosy about which applications they accepted, they became more stingy with the amount of credit they would extend, and they added new fees that merchants were generally unable to pass on to their customers.

 

Four Key Factors Drove Strong Performance

In its teleconference with investors, Signet management outlined four primary factors that drove its superior performance. Normally, we treat comments such as this as “idle prattle” for investors. But, that’s not the case with Signet. Jewelers need to study Signet – and Sterling – to understand what makes them better. These points that management outlined are not “window-dressing”; they are at the core of the company’s strategic and tactical goals.

 

·        Superior customer service – Every jeweler we know says they provide “superior customer service.” In our mystery shopping store visits, we get consistently superior customer service in Kay, Jared and Sterling’s regional brands. We do not get consistently superior customer service in many other chains. Nor do we get good customer service in far too many independent specialty jewelers, especially those who hire part-time employees who have no interest in jewelry other than cashing a paycheck every two weeks.

 

·        Best-in-class systems, including inventory management – Far too many jewelers run their open-to-buy from the back of an envelope. Not so with Sterling. They rely heavily on systems as well as research. They have the right products at the right time to meet their customers’ needs. They staff efficiently. They control costs down to the penny.

 

·        Differentiated merchandise – Today’s jewelry customer wants “something different.” Sterling gives it to them. According to management, differentiated merchandise across broad categories represented about 20 percent of sales in 2009. This included merchandise such as Open Hearts by Jane Seymour and Love’s Embrace. It also includes the expansion of the LeVian collection in the Leo Diamond collection.

However, if additional differentiated items – salted throughout Sterling’s merchandise lines – are added, perhaps up to 30 percent of the company’s total merchandise offering is differentiated from its competition.

Management did note that it is not “rushing” into differentiated merchandise, despite the fact that it generates a better margin and the company can control buying costs, especially with its economies of scale.

 

·        National television advertising efficiencies – Because Sterling is a national chain, it can buy national television advertising efficiently. It has the ability to pay for the best creative talent in the advertising industry, and as a result, Sterling has developed some of the most innovative and memorable advertising among large jewelers in America.

 

More Price Increases to Come?

Between February 15 and March 15, 2010, Sterling increased prices on roughly 30 percent of its merchandise. Management said that it decided to implement those price increases on merchandise where gold is a significant proportion of the cost. Gold accounts for about 20 percent of Sterling’s cost of goods sold.

 

However, management also noted that polished diamond prices were rising; this category accounts for about 55 percent of the total costs of goods sold. Our sense is that we could see higher retail prices on diamond merchandise at Sterling later this year, based on our interpretation of management’s comments.

 

In the most recent year, diamonds and diamond jewelry were 75 percent of Sterling’s sales, 7 percent of sales were gold jewelry, 11 percent of sales were “other” jewelry and 7 percent of sales were watches.

 

Jared Benefits From Pandora

Is Pandora just a passing fad, or is it here for the long term? Everyone would like to know the answer to that question. Sterling’s Jared division introduced Pandora, and it brought new customers into their stores. It also has served as a stepping stone to boost diamond jewelry sales. If Jared can hold onto those Pandora customers, it will have added significantly to its long term customer base.

 

Acquisition Policy Unchanged

One of the major wire services recently published a story about the possibility that Sterling Jewelers would expand by acquisition, based on comments to investors. We’ve read those comments, and there is nothing to indicate that the company’s acquisition policy has changed.

 

Signet Group’s Chief Executive Officer Terry Burman said, “…I can tell you that any opportunity that presents itself will be looked at through the prism of our internal rate of return requirements. We’ve got to hit our metric. If those opportunities present themselves, then we will evaluate them and see if they are in the strategic interest of business to pursue.” This statement by Burman is no different from any we’ve heard in the past.

 

The industry rumble calls for Sterling to acquire Zale. We think that’s unlikely for a variety of reasons, but the clearest reason is this: Zale is very sick, and Signet doesn’t run a hospital for sick companies.

 

New Store Openings to Remain Low

Net store space for Sterling Jewelers decreased by about 1 percent in 2009, a slightly smaller decrease than we had originally expected. In some cases, Sterling was able to obtain rent concessions from landlords in lieu of closing a store. This was a tough process because of Sterling’s pristine financials.

 

In 2010, we expect total new store openings to be lower than in 2009, and store closures should also be lower. This will result in an estimated 2 percent decline in store space. However, there will be an increased level of store refurbishment in 2010.

 

The following table summarizes store openings – actual in 2009 and estimated in 2010.

 

Kay Mall   Kay Off-Mall   Regionals   Jared (2)   TOTAL New Space Change January 2009 795 131 304 171 1,401 4% Opened 5 (1) 3 1 7 16   Closed (6) (5) (45) (1) 0 (56)   January 2010 794 129 260 178 1,361 (1%) Openings (E) 4 2 0 2 8   Closings (E) (10) (4) (36) 0 (50)   January 2011 (E) 788 127 224 180 1,319 (2%) Long Term Potential - Stores   850   500   100-200   300+   1,750+   (1)     Includes two stores rebranded to Kay. (2)     A Jared store is equivalent in size to just over four mall stores

 

Sterling has long been a market share leader in the U.S. During a recent presentation to investors, the company presented the following table which clearly illustrates that the company has been increasing its market share, based on total U.S. sales as a percentage of total specialty jewelry sales.

 

 

All market share numbers have been adjusted for acquisitions and divestitures.

 

How has Sterling taken market share? Simple: its sales have outpaced the industry average, as the table below illustrates.