Source: Company reports

After trailing Zale for years, Sterling Jewelers became the largest specialty jeweler in the U.S. in 2005. Sterling pulled ahead with sales that were 6 percent greater than Zale last year. Most noteworthy, Sterling posted this performance with just 1,221 stores versus Zale’s 1,365 U.S. jewelry stores (excluding Piercing Pagoda’s 812 units and Peoples Canada’s 168 units).

 

This year, Sterling is on track to widen its lead as the largest specialty jeweler in the U.S. during 2006. Based on preliminary estimates, Sterling’s 2006 revenues could be as much as 14 percent greater than Zale’s U.S. revenues.

 

What’s Behind Sterling’s Ascension to the Top Spot?

Two factors help explain how Sterling rose to the top position among America’s specialty jewelers:

• A focused, methodical approach to growth
• Woes at Zale Corporation 

The tale of Zale’s turmoil has been told and re-told: management turnover, especially at the top, has been excessive; the company has lost market share; net new store growth has been nearly nil; a major market re-positioning at the flagship brand – Zales Jewelers – failed; and, erratic inventory flow hurt, especially during the all-important 2005 holiday selling season.

 

In contrast, Sterling Jewelers, under the leadership of Terry Burman, has quietly been focused on building its business. In its Annual Report to shareholders, Burman lists the four strengths that led to the company’s superior performance:

• Uncompromising customer service (a diamontologist in every store)
• Merchandising for superior value (the Leo Diamond)
• Increasing brand awareness (“Every Kiss Begins With Kay”)
• High quality real estate (excellent store locations)

While these may seem like typical management platitudes in anticipation of a shareholders’ meeting, they have translated into solid, consistent sales and profit performance.

 

In fact, for London-based Signet Group, which owns Sterling Jewelers, the U.S. based division is its crown jewel. Sterling generates 73 percent of Signet’s revenues and 77 percent of its operating profit with just 66 percent of the corporation’s net assets.  

Here are some highlights from the company’s Annual Report as well as recent legal filings with the Securities & Exchange Commission.

 

• In 2005, Sterling Jewelers had an 8.2 percent market share in the U.S. among specialty jewelers (about 28,000 stores generating $28 billion in sales) versus Zale’s 7.8 percent. For the total jewelry industry (including jewelry sales by all categories of retailers – more than 128,000 units generating over $59 billion of sales), Sterling Jewelers had a 3.9 percent market share.

• Sterling’s average sales per store are well above the industry average, as the graph below illustrates.
  

Source: Company reports, JA, AGS

 

 

• Sterling’s average ticket is about in line with the industry average, as the following graph illustrates. The conclusion that we can draw from these two graphs – Sterling’s average ticket is lower, but its sales per store are higher – is that Sterling generates far more customer transactions. Our mystery shopping excursions suggest that Sterling’s sales people are more aggressive at trying to complete a sale. Further, there are typically more Sterling sales people per store than at the competition.

Source: Company reports, JA, AGS

• Sterling’s total sales in 2005 were up 12.1 percent versus a modest 2.7 percent sales gain posted by all U.S. specialty jewelers. Total U.S. jewelry sales (from all retailers including discounters, department stores, and all others) rose by 3.8 percent in 2005. Sterling’s same-store sales in 2005 rose by a very strong 7.1 percent.

• During 2005, Sterling’s new store space increased by 9 percent. In 2004, its new store space grew by 8 percent. Compound annual growth in new store space over the past five years has been seven percent.

• Sterling has been investing heavily in both new stores and store refurbishment projects over the past five years, as the following table illustrates.

Source: Company reports

• The change in store units by each U.S. brand is illustrated on the table below.

Source: Company reports

• Sterling increased its gross marketing spend in 2005 to 6.7 percent of sales from the prior year’s 6.6 percent. Total marketing expenditures climbed by 12.7 percent.

  Source: Company reports

• Management noted that due to its rising diamond sales mix, its gross margin has declined about 100 basis points (one percent) over the past three years. Sterling’s diamond sales mix reached 71 percent in 2005, well above the traditional jeweler who generates about 50 percent of his revenues from diamonds and diamond jewelry (see graph below). The table at right summarizes Sterling’s sales mix by product. Exceptionally strong diamond demand by U.S. consumers has been particularly beneficial to Sterling’s sales growth, due to its high diamond sales mix.

Source: Company reports

 

Outlook: Accelerated Growth Prospects

• As outlined in management’s report to shareholders, Sterling’s initiatives for 2006 including the following:
  • Store operations & human resources
    • Improve jewelry repair business
    • Continue testing e-learning
  • Real estate
    • Increase Jared openings
    • Roll-out off-mall Kay stores
    • Test outlet center Kay stores
  • Merchandising
    • Expand range of diamond jewelry, including larger, higher-priced stones
    • Test superstore concept in high traffic malls
    • Extend luxury watch collection in Jared
  • Marketing
    • Increase Kay and Jared television advertising
    • Expand trial of JB Robinson TV ads into two additional markets
    • Launch e-commerce capability for Kay

• The company has accelerated its outlook for new store space in 2006 to a range of +8 percent-10 percent from its prior goal of +7 percent-9 percent.

• Management noted that it would consider acquisitions to help meet this lofty growth goal.

• By brand, Sterling management outlined its growth expectations for the current year.

• Kay Jewelers – Last year, sales in this 781 store division were up 9.9 percent. During the current year, management is expecting 23-28 net new mall stores. In selected malls, a superstore format, based on a combination of Jared and the recently launched metropolitan store concept, will be tested. The trial of Kay in open-air retail centers was successful; the rate of openings of this concept will increase to 20-25 units this year (versus 11 openings last year). Three stores in metropolitan locations opened in 2005; two more sites will be added this year. Sterling plans to test Kay Jewelers stores in outlet malls in 2006, with five units planned. In the aggregate, the Kay Jewelers division is expected to expand by 50-60 stores in 2006
• Regional chains – The leading brands in this group include JB Robinson Jewelers, Marks & Morgan Jewelers, and Belden Jewelers. This group of 330 mall stores posted a modest 2.8 percent sales gain in 2005. These regional stores provide the potential for Sterling to develop a second national mall brand of sufficient size to justify the cost of national television advertising; this would require about 550 units, a number which can be achieved over the next few years by a mixture of new store openings and acquisitions. Management plans to open 10-15 net new stores this year.
• Jared – This group of 110 jewelry superstores generated a dramatic sales gain of 29 percent in 2005. In terms of square footage, a Jared store is the equivalent of about four mall stores. However, it generates revenues that are equivalent of about five mall stores. The Jared concept is the primary vehicle for U.S. growth. Last year, 18 Jared units opened; this year, 18-23 units are projected to open. Some new Jared units are being opened to test new real estate selection criteria which may increase the potential number of sites which would be suitable for this concept, such as locating the stores attached to the exterior of conventional covered malls. In addition, Sterling is considering a metropolitan market test of Jared. No one else in the jewelry industry has successfully rolled out a major chain of jewelry superstores. Jared’s typical customer has an average household income of $92,000, well above the typical jeweler customer’s demographics. Further, the typical Jared customer has a higher educational level and is more likely to own a home.

• During the second half of 2006, Kay plans to launch a new website with e-commerce capability. So far, none of Sterling’s U.S. brands have sold jewelry online.

• Management noted that two of its three off-mall concepts have shown potential: 1) stores in lifestyle centers with upgraded tenants such as Crate & Barrel or Williams Sonoma and plenty of restaurants; and, 2) power center stores that are dominated by big box retailers such as Borders and Toys R Us. Kay’s test stores in traditional off-mall locations, which are dominated by grocery stores and community retailers, have fared less well.

• Longer term, Sterling’s management believes that there is potential to double U.S. selling space by continuing to focus on existing retail concepts. The planned growth in U.S. stores, along with the long term potential, is shown on the table below.

Source: Company reports

• “Getting closer to the mines” – Some in the industry believe that Signet’s long term goal is to become a DTC Sightholder. Management has dodged this question in public. However, on a recent conference call, it noted that too much “non valued-added” costs are involved in diamond trading activities. The company’s goal is “to get closer to the mines,” which would eliminate some non value-added costs. Management noted that the future of its initiative will be based on the proportion of rough diamonds which it will need to sell off, a process that nets little or no margin. In addition, management noted that another benefit of trying to source rough stones as well as cutting and polishing them is that it will help the company understand what happens in the cutting and polishing operations, which will yield greater transparency and help Signet negotiate better with cutters and polishers. Despite this new program of getting closer to the mines, management noted that the “vast majority” of its diamonds will be bought from cutters and polishers.

• Control of credit sales – The typical U.S. jeweler relies on extended credit (monthly payment plan) to finance 40-50 percent of total revenues. Most jewelers have gotten out of the “banking” business and now use a third party to finance sales. Sterling, unlike most of its mass market competition, still finances its own jewelry sales. The primary advantage of controlling credit availability is that the jeweler can boost sales by loosening credit. For the past three years, Sterling’s revenue mix of credit sales has crept up, and now stands at 51.1 percent of sales for 2005. Its bad debt, as a percentage of credit sales was 5.8 percent in 2005, slightly higher than prior years. It appears that Sterling has solid control over its credit operation.

Source: Company reports