Now, the tables have turned: Harry Winston’s 19 retail stores generated nearly $335 million in sales for the most recent fiscal year ended January 2011, and posted a profit of just over $10 million. That’s a $27 million turn-around in profits from the prior year’s loss of just over $17 million. Retail sales were up a dramatic 53% during 2010 (FYE January 2011) versus the prior year.

 

If the year’s results are impressive, fourth quarter financials were even more spectacular: sales in the retail division were up by 89% to nearly $133 million from last year’s $70 million, and profits were just over $10 million in the January 2011 quarter, a $20 million swing from last year’s loss of $10 million in the fourth quarter ended January 2010.

 

Retail Division Still Has a Long Way to Go

When Aber Diamond Chairman Bob Gannicott announced the acquisition of Harry Winston Diamonds several years ago (and subsequently changed the corporate name from Aber to Harry Winston), he said that his strategy was to “book-end” the jewelry industry. Based on his analysis, the real profits are made in either the mining sector or the retail sector. We agree with his analysis.

 

The only problem has been this: Harry Winston’s retail division has never performed anywhere near its potential. Even in the most recent year – arguably a turn-around period – Harry Winston’s pretax margin on its retail division was a modest 3.0%, at the low end of the range for a typical independent specialty jeweler in the U.S.

 

In contrast, Tiffany posted a pretax margin of nearly 18% for the year ended January 2011. Signet Group, which operates stores in the U.S. and the UK posted a corporate pretax margin of 8.7% for its most recent year ended January 2011, with an operating margin of 12.5% in its U.S. Sterling Jewelers division. But after four straight years of losses in Harry Winston’s retail stores, there is reason to celebrate this year’s turn-around.

 

One could argue that it is tough to make a large profit in the Harry Winston stores, especially since its extremely high value average ticket carries an inherently low margin. But its business is all about sales volume: with high fixed costs, Harry Winston’s challenge is to boost sales. When sales rise, profits will come flooding to the company.

 

Financial Highlights

The following table summarizes financial highlights for Harry Winston’s retail stores division for the fiscal year ended January 2011.

 

 

The following are highlights from management’s conference call with analysts as well as other legal filings.

 

·         Regarding the recent tsunami in Japan, the company said that Japan accounts for roughly 11% of global diamond jewelry demand, and 18% of Harry Winston’s retail sales. (We note that in pre-recession years, Japan accounted for 25-30% or so of global diamond jewelry demand; Harry Winston’s figure is for 2009, the latest reliable data available.) Harry Winston management warned investors that Japan’s woes will have a negative impact – at least for the short term – on the company’s results in that market.

 

·         All geographic regions where Harry Winston operates posted solid sales gains during 2010, though some regions performed better than others, as the table below illustrates.

 

In the U.S., sales rose due to increased tourism related largely to the weaker U.S. dollar. In addition, the strong recovery in the equities markets helped boost consumers’ “wealth factor.”

Sustained high-energy prices drove increased demand from Middle East and Russian customers. European sales were driven by increased store traffic, largely tourists from China.

Sales in Japan were up 24%, with sustained demand for bridal jewelry. Sales in Asia, excluding Japan, were up 169% over the prior year.

 

·         Management noted that the company’s extremely strong sales gains were driven by jewelry demand, not watch demand. This seems to be a recurring theme among jewelers; Tiffany reported similar trends for its year that just ended.

 

·         In an effort to bolster watch sales, Harry Winston plans to increase the number of wholesale doors selling its branded watches. Currently, Harry Winston branded watches are sold in about 185 doors; the company plans to add 35 to 45 more doors during 2011, ending the year with roughly 225 doors, a 14% increase.

 

·         Harry Winston also provided some details for its “partner salons.” First, revenue from those salons is not based on royalties, but rather wholesale revenues. There will be some collaboration on the capital investment required. Harry Winston provides its partners a “book of guidance” which apparently gives highly detailed guidance on both the operating systems and the “look” of the stores and displays. Management noted that “you will not see a difference between an internally run salon [versus] a partner salon.”

These salons will be opened mostly in the Middle East and Russia, and perhaps China, where the company does not have a true understanding of the local clientele. Further, the company might authorize partner salons in smaller, second-tier markets around the world. The challenge, of course, is to keep Harry Winston exclusive enough to continue to attract ultra-rich consumers without cheapening the brand by expanding it to the mass market.

In response to a question about potential operating margins of those partner salons, management said that the margins might be smaller, but operating costs for Harry Winston would be nearly nil. Thus, the return on investment could be very large. Virtually any profit from sales will drop directly to Harry Winston’s bottom line.

Management also noted that, despite a lot of talk about these partner salons, their revenue contribution would be “very small compared to the development of the core business driven by bridal collections and watches.” The partner salons will help the company extend the Harry Winston brand into new markets, but it will be only a minor part of the overall corporate business.

 

·         Harry Winston’s gross margin fell in both the fourth quarter and full year due to a greater sales mix of high value jewelry that carries an inherently lower margin. For the full year, the company’s reported gross margin was 47.1%, at the low end of the range for independent specialty jewelers in the U.S. market.

 

·         Harry Winston noted that it will continue to increase its marketing, advertising and promotional investment in its brand. It does not disclose the percentage of sales it spends on these activities. Recently, the company launched a new advertising campaign with a celebrated photographer and a Danish supermodel, featuring “celebrations of meaningful moments.”

 

·         While we do not provide analyses of the rough diamond operations at Harry Winston, we note that management said that the company’s rough diamond prices have increased 23% in the past year, in line with the market.

 

Management’s Outlook – Above Average Growth Targeted

Harry Winston management outlined its outlook for longer-term growth.

 

·         Long term, Harry Winston management believes that the company’s sales will grow more rapidly than overall luxury market growth. This means that annual revenue growth will likely be in the mid-teen range over the next five years.

Three product segments are expected to help drive sales growth: timepieces, bridal and jewelry collections.

 

·         Over the next five years, Harry Winston hopes to expand its sales of timepieces from 3,500 annually – at roughly $50,000 per timepiece – to 15,000 timepieces annually, at a lower average price. Management says it has the capacity, the technology and the design to support this growth.

A new timepiece, Midnight by Harry Winston, has more accessible starting price points – at about $14,000. This will allow Harry Winston customers to buy everyday watches in addition to the collector pieces and ladies dress watches that have performed well historically.

 

·         Management’s primary focus will be on improving margins. Gross margins could rise to the low 50% range, while its operating margin could rise to the low-to-mid teen range over the next five years.

The company plans to open three new stores in 2011, including two in Shanghai, China. It recently opened a new concept salon in Las Vegas.