After posting well-above average sales gains for years, Signet Group – and its U.S. affiliate Sterling Jewelers – has posted its fourth consecutive quarterly decline in same-store sales. For the third fiscal quarter ended October 2008, the company’s same-store U.S. sales fell by 7.9 percent.

 

Because of market uncertainty, the company has effectively canceled its new store expansion plans in 2009 – net selling square footage will be little changed from the end of this year. In an effort to boost sales in existing stores and differentiate itself from its mall competitors, Sterling is focusing promotions on its exclusive brands and exclusive merchandise. This strategy makes good sense: leverage your existing revenue-producing assets before you add new stores in unproven markets.

 

The following table summarizes financial results for the company’s third fiscal quarter – August, September, October 2008. All results are shown in constant dollars, and may differ from results reported earlier by the broad media. Constant dollar results eliminate currency translation swings, and reveal true apples-to-apples comparisons.

 

For example, because of significant strength in the U.S. dollar in the third quarter, currency translation accounting caused U.K. sales to be reported down by 15 percent. But this does not reflect the reality of the market. In local currency, sales in the U.K. were down just over 4 percent, a much more meaningful figure which accurately reflects the underlying demand in that country.

 

Highlights from the third fiscal quarter ended October 2008 were as follows:

 

• In the U.S., same-store sales were down 7.9 percent in the quarter. However, same-store sales declined by about 11 percent in the final seven weeks of the quarter. That final period includes all of October and most of September, when the global financial markets were in turmoil.

• Management said that clearance and going-out-of-business sales among specialty jewelers in the U.S. – a few chains and some independents – had an adverse affect on Sterling’s sales.

• Sterling’s average ticket rose by 5.7 percent in its mall brands (primarily Kay). The average selling price was also up for Jared, but management did not specify the percentage gain. We believe that Jared’s average ticket was negatively affected by the introduction of a new line of charm bracelets with a low average price point. Further, there were fewer large ticket transactions at Jared, especially in the final seven weeks of the quarter.

• Management noted that the declining price of gold not only hasn’t had much of an impact on its sales and margins, but won’t have much impact on its retail prices in the fourth quarter, for three reasons: 1) its inventory turn is too slow to reflect the rapid fall in gold prices over the past couple of months; 2) the company uses “average cost” methodology for inventory valuation and pricing; and 3) hedging positions which help stabilize gold prices, but can be a negative factor in a market with falling prices.

• Signet has discontinued its rough diamond initiative. While this experiment operated at about break-even, the volatility in the rough diamond market, coupled with pricing uncertainty in the polished diamond market, represent a distraction from the company’s core retail business. However, Signet group chief executive officer Terry Burman said that the company might consider starting it up again, if conditions change. The cost to close the rough diamond procurement, cutting, and polishing operation are not material.

• Sterling’s bad debt charge (this is an actual charge, not a provision) was 4.8 percent of U.S. sales versus 3.3 percent last year. Credit sales mix was up nearly a percentage point year-to-date. About 50 percent of Sterling’s sales utilize in-house credit. However, there has been a significant increase in the credit disapprovals, offset by a larger number of credit applications. (We note that Signet does not provide a “provision” for bad debt; its charges are a direct write-off of the account, essentially when it ages past 90 days. Other credit jewelers – notably Friedman’s – used a “provision” or estimate of bad debt; that’s what got them into trouble.)

• Signet has now began reporting financial results in accordance with U.S. GAAP (this has been an evolutionary process). This means that its financial ratios are now more in line with other publicly held jewelers, though they still don’t seem to correlate as closely as we would expect.

• Gross margin – 27.8 percent versus 28.8 percent - Signet’s gross margin fell by 100 basis points in the third fiscal period, when compared to the same fiscal quarter last year. We believe there are five key factors that had a negative impact on its margin: 1) an unfavorable change in sales mix; 2) a more promotional environment; 3) an increase in the bad debt charge; 4) a lack of sales leverage for relatively fixed costs; and 5) costs related to new immature stores with below-average sales levels (it takes 4-5 years for a store to reach maturity).

• Operating costs – 34.5 percent versus 31.1 percent - Signet’s operating costs rose substantially in the quarter, as a percentage of sales. While management has been diligent in controlling costs, recent sales weakness has hurt efficient absorption of relatively fixed operating costs. 

• We are also impressed with the company’s management of its balance sheet. Even though Signet’s total store base increased by 2 percent, its inventories were down nearly 7 percent, though some of this is due to currency translation. Further, its vendor payables were down 48 percent, with only a moderate increase in debt. Clearly, the company is closely managing its cash.

• Other financial reporting also changed due to the move of the primary listing of the company’s shares to the U.S. on September 11, 2008. The company implemented a 1-for-20 reverse split of its shares, so earnings per share calculations have also been restated.

• In the all-important holiday selling season, advertising expenditures will be about flat with last year. However, due to media price inflation, the number of impressions will be down by a mid-single digit level. Radio will be not be used in the fourth quarter.

• New advertising initiatives will emphasize the exclusive brands that Kay carries. In addition, actress and artist Jane Seymour will be featured in Sterling’s ads. Three new collections from LeVian have been introduced. Other initiatives include the promotion of champagne and black diamonds as well as an expanded of Russell Simmons jewelry.

•  Looking ahead, the company plans essentially to add no net new selling square footage in 2009.