Previously, I wrote about the importance of identifying the competitive structure of a business. Good investments are mostly either strong commoditybusinesses or weak franchises. The competitive structure of a business determines the predictability of its future cash flows. If you can predict future cash flows to a high degree of certainty, then it is easy to see whether you are being offered an acceptable margin of safety in relation to the market value of the business. And, a margin of safety is what investing is all about.

I immersed myself in the world of US jewellery retailing for the last two weeks and only recently surfaced. Of course, you have to be nuts about business to do this kind of thing but (as usual!) I had a great time and learnt a lot. These things always start with a mountain of paperwork that has to be waded through. I load up the on the refreshments, close the door, put up the ?Please Do Not Disturb? sign and get stuck in there.

The US Jewellery business can broadly be split into two categories: the specialty retailers and the discount retailers. Although Wal-Mart is the largest jewellery retailer in the States, I focussed on specialty retailers. This is a commodity business and in commodity businesses size counts. The top 40 retailers have around 6,500 stores between them and the industry 24,000.

The rankings are more or less as follows:

1. Zale 2,300

2. Sterling (Part of the UK company Signet Plc) 1,130

3. Friedman?s 650

4. Fred Meyer (Part of Kroger) 436

5. Whitehall 369

6. Helzberg (Part of Berkshire Hathaway) 240

7. Crescent 155

8. Samuels 127

9. Reeds 100

10. Ultra Stores (currently in Chapter 11) 99

12. Ben Bridge (Part of Berkshire Hathaway) 68

17. Tiffany & Co 44

40. Call Jewellers 10

Things are complicated a bit by companies, like Finlay Fine Jewellery Corp, which are referred to as ?Leased Jewellery Department Operators?. Finlay has just over 1,000 leased departments in department stores and, with turnover of around $1bn, obviously cannot be ignored.

In a perfect world, the larger the business is, the more operational leverage it will have - and therefore the more profitable it will be, right? As with life, things are not always that simple. I looked at store count, market niches, financial leverage, etc. What I found was that it all boils down to management in the end, as is the case with any retailer. As Buffett rightly pointed out, ?Buying a retailer without good management is like buying the Eiffel Tower without an elevator?. So, if you are seeking companies with a competitive edge in the US jewellery retail industry I would suggest focussing on their management. Just as the return on equity for these companies ranges between 7% and 27%, so the quality of management ranges between the inept and the admirable.

What I sometimes do is to head for the Berkshire stable of businesses to see if we have anything to use as a benchmark. Of course, I wasn?t too surprised when I found the most profitable jewellery retailer in the US and also two of the most admirable belonging to Berkshire. The most profitable is Borsheim?s and the other two are Helzberg Diamonds and Ben Bridge Jeweller. Susan Jacques heads up Borsheim?s, which has operating costs of 18% of sales, compared to an industry average of around 40%. Jeffery Comment runs Helzberg, which has the highest per store turnover in the industry: just under $2,2m per store. OK, Tiffany?s averages over $17m, but it is not directly comparable to the typical operator in the industry. Some reports have it that Ben Bridge is also averaging in excess of $2m per store. The rest of the industry is mostly averaging between $1m and $1.5m

Discussing business secrets with Susan Jacques, Jeff Comment and Ed Bridge soon highlights that the jewellery business is all about managing the business correctly, in order to treat the customer right. Top management has to have a relentless focus on detail. For Jacques it is important to be consistent, honest and have high integrity. You have to surround yourself with the best team you can find and focus on keeping the customer happy. Jeff Comment will tell you time and time again that you have to be passionate about the business. Speaking to him you immediately sense that this guy is focussed on keeping all the stakeholders happy, namely the customers, employees and the shareholders (Berkshire). Jon Bridge best described what the jewellery business is about when he said, ?Jewellery is a blind commodity for the vast number of people in our world. People want it, people love it, but on the other hand they don't know what it is. It's a material that we place a very high value on. But it doesn't run like a car and take you from one place to another. It has beauty. You have to trust whoever is selling it to you, that they know what they're doing. So much of the whole idea is TRUST?. Buffett echoes this when he says that if you don?t know jewellery, know your jeweller.

I am neither going to attempt to give you a summary of the managements of the US specialty jewellery industry, nor am I going to give you a checklist to judge management by. What I will say is this, though. If you spend the time on getting to know these businesses by reading the 10k?s, 10q?s, annual reports, news clippings, interviews with management etc. you will realize that the quality of the different managements is like chalk and cheese. You will find companies with immense capital behind them and serious MBA talk, the normal corporate sluts who can?t stay with a company for more than a few years and then the few gems.

However, I will leave you with an example of what I believe you should look for. This is an excerpt from X that I edited, because I don?t intend to give away any good investment ideas.

?Today, our Company is 110 years old. It was founded by David Aitkin, a distant relative of mine, and then run by my grandfather, Chuck Anderson, for whom I am named. He passed away in 1948, two years before I was born. I have always regretted not meeting him, but I feel I know him from the stories I have heard and from being a part of the business, which I now manage. After my grandfather passed away, the business was run by his children, including my mother, Sarah Friedman. Along with my brother Mat and my partner John Higgins, I joined the Company in 1979. We have seen it grow from fewer than a dozen stores to the 250 stores we operate today. Working with many others, we have created a unique, differentiated and lower risk jewelry store concept, which has a long track record of successful and profitable growth.

I am the fourth generation of this family to lead this business. I take this obligation very seriously. I am proud of my executive team including Sarah, John and Peter Bracken, our support office staff and our store supervisors, managers and associates. It is a group of hard working and caring individuals who have dedicated themselves to maintaining the principles, ethics and practices of the successful business of which we are all a part. I am proud of our team, I am pleased with the results of fiscal year 2001 and I look forward to the challenges and the opportunities of fiscal year 2002 and beyond.?

Alternatively, you could just buy a couple of Berkshire shares and pocket the best-run jewellery businesses in the USA.

Whatever you are up to, I hope it is profitable and ethical!

Mr. B

mail_mrb@yahoo.com

Posted: 2003/02/24 08:04 View Archive