Zale’s Same Store Sales Debacle

“On a percentage basis as you can see, that’s a huge hit for Zale’s coming in with same-store sales that fell more than 18%.” — Fox Business Network 12/7/2009

After the close of trading on Friday, Zale’s Corp. (ZLC) reported in a regulatory filing that same store sales had slipped 18.6% in the month of November. This is a particularly disappointing time of year for such a wide loss because traditionally the company can expect about 25% of their revenue in the month of November. The horrendous results for Zale’s prompted analysts at Soleil to downgrade the stock to Sell from Hold. The downgrade and the comparable sales numbers have sent the stock reeling, knocking nearly 25% of the market value out in one fell swoop.

Clearly, Zale’s is facing a challenging holiday shopping season, and they have found it necessary to close a large number of underperforming stores over the last year. Through the most recent quarterly earnings report in September, the company had closed some 191 stores and kiosks or nearly 10% of their locations. If November’s sales results are any indication, there could be more store closings in the months ahead.

Looking at Zale’s compared to its closest competitors, it is clear that Zale’s is the laggard in the group. For example, after today’s loss Zale’s stock is down more than 8% over the last twelve months which has greatly underperformed the S&P 500’s impressive 26% gain. The three closest competitors to Zale’s are certainly Signet Jewelers (SIG) and Tiffany & Co. (TIF) with their large retail presence, and also Blue Nile (NILE) which is the web’s largest jeweler. Each of these companies has easily outperformed the benchmarks as TIF is up 75%, SIG nearly 200% and NILE is 134% over the past twelve months. Normally, we see an opportunity when a stock has so greatly underperformed its peers, but in this case it is plainly obvious that Zale’s is struggling greatly. There is huge short interest in the stock at this point, and they have thus far been proven correct.

As a value investing shop, despite the horrid performance in November, Zale’s is actually starting to look more attractive. There is little doubt that Zale’s expanded too much in the past and now they are actively trying to shut its near empty stores. We would expect the current closing schedule to continue which will help them constrain costs in this difficult sales environment. We currently have a Fairly Valued stance on ZLC, but if we start to see some fundamental improvements, we could be moved to upgrade in the next few months as it has become quite cheap. It is worrisome that debt to assets ticked up above their historical norms over the last couple of quarter, but we think the balance sheet is decently strong at this point. If they can keep their debt under control and start to improve profit margins by closing poor performing locations, we may reassess our rating for a long term value investor.

Zale’s Same Store Sales Debacle

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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