Loading...

The story of Zale Corporation (ZLC) is unlike many of the other profiles in the “From the Survey” section of Value Line’s Web site. For starters, Zale went bankrupt once and came close to filing for Chapter 11 a second time just a few short years ago. This is a comeback story about a company that was in dire straits and, with the direction of new management, made the correct decisions that helped save the company. Still, despite the encouraging news, it should also be pointed out that Zale is only in the early stages of its turnaround, and a happy ending for investors is certainly not guaranteed.

Founded in 1924, Zale Corporation is one of the largest specialty retailers of diamonds and other jewelry products in North America, operating 1,715 retail locations throughout the United States, Canada, and Puerto Rico, as well as online. The company’s brands include Zales Jewelers, Zales Outlets, Gordon Jewelers, Peoples Jewellers, Mappins Jewellers, and Piercing Pagoda. Zale first experienced major problems in 1992 when it was forced to file for bankruptcy. After less than two years, the company was back on its feet and recovering nicely. Indeed, in 2008 it was enjoying a very successful year when the financial crisis hit, and the company was nearly bankrupted for a second time. Indeed, after the stock hit a high of over 42 in the middle of the year, the price of the equity crumbled to less than 3 before the year was out. High-end items are purchased with discretionary funds, and these are the first items to be cut from consumers’ budgets when hard economic times hit. This was the case in 2008, as a massive rise in unemployment resulted in the demand for non-essential items, such as diamonds drying up precipitously

Since late 2008, Zale has been operating in emergency mode. In the early 2000s, it had been expanding its store base during the good times, eventually reaching 2,349 locations by 2006. As the economy went into a free fall in 2008, Zale began to shutter stores and by year-end 2009 had closed more than 300 locations. Since that time, the company has pared the total to about 1,700. Moreover, we estimate another 50 locations will be closed within the next fiscal year and continue to close at this pace for the foreseeable future.

Over the long term, we expect the diamond and jewelry business to experience some major changes. Currently, Blue Nile (NILE) and Amazon.com (AMZN) are the two biggest concerns that sell diamonds on the Internet. As customers get more comfortable spending on high-priced items online, this could present problems for Zale. For starters, this method provides Zale’s competitors with a solid financial advantage because online selling is much cheaper for the companies as capital outlays for expensive brick and mortar for traditional retails stores is not needed. One way the company is trying to overcome this disadvantage is a newly launched program in which prospective customers can have a diamond sent to a specific Zale store for examination in person. Of course, Zale assigns a specially trained salesperson to meet with the client to help “close the deal.”

When Zale reported fiscal 2013 earnings (ended July 31st) recently, it managed to post a profit of a few pennies a share. (In the previous quarter, the company earned a third-quarter profit for the first time in seven years.) The reaction to this data by Wall Street has been close to euphoric. Zale shares, which sold for as low as $3.80 this year, are now trading close to $14. Many investors and analysts believe that this is just the beginning of a resurgence. Research reports on Wall Street are already forecasting earnings to justify large advances in the stock price. It is possible that Wall Street is well ahead of itself in this regard, though.

An important factor to remember about Zale’s turnaround is the influence of private equity firm Golden Gate Capital. A respected expert in dealing with distressed retail companies, it is partially responsible for the company’s success. Golden Gate’s expertise and capital did not come cheaply to Zale, however. As part of the rescue agreement with Zale it was granted 11 million warrants to purchase Zale stock at $2 a share. If exercised. This will result in a 20% increase in the amount of shares outstanding.

Investors should also keep in mind the volatility of the stock and the fact that the company can exhibit a vast swing in its fortunes in an extremely short period of time, such as in 2008 when the company saw its stock price fall 93% from its high.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.