Whitehall Jewelers JWL
December 11, 2001 - 10:35am EST by
2001 2002
Price: 9.91 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 146 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Whitehall Jewelers, Inc. is a mall-based jewelry retailer. Whitehall achieves by far the highest returns on capital in the industry, has excellent free cash flow, and grew operating earnings at a 26% annual rate from ’94-’00. Yet they trade at a discount to the rest of the industry and are currently trading at less than 6x normalized earnings. I don’t know when the recession will be over but the valuation of Whitehall implies that it will never end. This is a great company that has yet to be discovered and is selling at a dirt-cheap valuation.

Whitehall currently operates 367 stores, with roughly 75% being under the Whitehall brand name and 25% being under the Lundstrom brand name. The economic slowdown has hurt luxury goods dealers to a greater degree than retailers on average and the stock price has suffered greatly as a result. However, Whitehall is simply the best company in this industry and the numbers bear this out.

Their average ROIC for the past 5 years has been 16.1%, opposed to 10.7% for their competitors. 5-year ROE has been a very healthy 26.3% as opposed to 15.4% for their competitors. They've grown their earnings at a 26% annual compounded rate from 1994-2000. They've also roughly doubled their store count in the same time frame. And they’ve done all this without leverage. Their LT debt/equity ratio is 0.08 and they have been reducing LT debt in recent years.


Whitehall has been unprofitable the last three quarters as a result of the recession, so it’s necessary to get a picture of their normalized earnings. Here is some selected data for the four years prior to the recession:
1999 98 97 96

stores 310 250 191 164
revs/store $1.2mm $1.1mm $1.1mm $1.0mm
op. margin 11.8% 11.4% 11.7% 12.2%
ROIC 22.2% 17.9% 17% 15.3%

As you can see,Whitehall had been increasing its returns on capital and revenues per store, and had maintained its’ operating margin from ’96-’99. To formulate normalized earnings I will take revenues per store as $1.1mm and operating margin as 11.5%. The current store base stands at 367.

Revenues = 367*$1.1mm= $403.7mm
Operating Earnings = $403.7mm * 11.5% = $46.4mm.

At the end FY2000 the store base was at 361 and D&A was $10.3mm. The store count is similar so I'll use the same number for D&A. The market cap currently stands at $146mm, LT debt is $8.5mm and cash is $2.8mm.

EBITDA = op. earnings + d&a = $56.7mm
EV = $146mm + $8.5mm - $2.8mm = $151.7mm
EV/EBITDA = 2.7x

IMO it’s a matter of when, not if, Whitehall will return to its’ historical margins. So when the economy does recover you will have a company that had ROC of 22.2% in ’99 and had grown operating income 26% annually from ’94-’99 selling at an EV/EBITDA of 2.7x. This is much too cheap for a company with the growth opportunities and high returns on capital that Whitehall has.

Now to get normalized net income and EPS: In FY00 Whitehall had interest expense of $5.7mm. Total debt load has come down since then and so have interest rates, so I’ll peg interest expense at $5.0mm. And I’ll apply the 38% tax rate.

Net income = ($46.4mm - $5.0mm) * 62% = $25.7mm.
Share count = 14.6mm
EPS = $1.76

So at a price of $10/share the normalized P/E is 5.7x. JWL sold at a 20x P/E at the last peak of the cycle but even if it gets to a P/E of 15 that brings the share price up to $26.40. Given their ROC and their growth opportunities I believe the long-term value of the shares is much higher.

I use the following method to get FCF for Whitehall:

FCF = (net income) + (d&a) – (cap. Ex) + (new store openings) * (investment in a single new store)

It costs Whitehall about $595,000 to open a new store. I explain how to get this number below.

So for ’99: FCF = $19.3mm + $7.6mm - $22.2mm + (60 * $0.595mm) = $40.4mm.

EV/FCF = 3.75x

Again this is super-cheap and FCF should ultimately be higher because the current store count is 57 stores higher than in '99.

Why does Whitehall earn better ROC than its' competitors?

-Whitehall's average store size is roughly half that of the average mall-based jewelry store. Yet they generate comparable revenues per store. This has a two-part benefit. First, it keeps occupancy expenses down. Secondly, it allows them to have a greater selection in mall location. Management has said their advantage in getting the highest-traffic mall locations is an overlooked, but key competitive advantage to their business.

-Whitehall's management has an excellent ability to pick store sites that will bring in a lot of sales.

-Whitehall usually operates two or more stores in the same mall. This allows them to realize economies of scale in distribution, buying, advertising, and personnel.

-Unlike other jewelry stores, Whitehall doesn't extend credit to consumers. They don’t have to worry about customers defaulting on their payments and this also reduces their DSOs.

-Employees receive base pay, but a major part of their compensation is tied to store performance and individual performance. This is a major factor behind Whitehall's significantly higher than average revenue/square foot.

-Management is focused on profitability, not market share, revenues, or number of stores. As a result they have a very disciplined approach to opening new stores. They will not open a new location unless they feel it can produce positive operating cash flow (defined as operating income + D&A) in the first year. Most new locations do indeed prove successful in this regard.

-Whitehall only pays for 60% of their merchandise inventories. The rest are financed through payables and consignment.

Because of their cost structure Whitehall can beat other jewelry stores on price but be just as profitable. To illustrate this, over the last three years Whitehall has averaged a 40.8% gross margin, while Zales (the largest mall-based jeweler) has averaged 48.6% gross margins. Yet Whitehall’s net margins have been equivalent to Zales.

Case Study of Opening a New Store

To better illustrate how Whitehall earns high ROC I’ll give some detailed info on the costs and returns when a new store is opened. Cap-ex associated with a new store opening is approximately $225,000. Each store holds about $500,000 in inventory. 40% of this inventory is financed through payables and consignment so the net inventory cost to Whitehall is $300,000. Average lease expense is $70,000/store/year. Revenues/store are $1.1mm and the operating margin is 11.5%.

Capital Invested in new store = $225,000 + $300,000 + $70,000 = $595,000.
Operating Income = $1.1mm * 11.5% = $126,500
ROIC = 21.3%

Due to their unique store structure Whitehall is head and shoulders above their competition in this regard. Jewelers with larger stores have higher lease expenses and higher inventory needs, but generate a comparable amount of revenue/store.

Future Strategy

Whitehall has slowed down their store growth during the recession, but once the economy recovers they will resume their growth strategy. With a current store base of only 367 stores there is plenty of room for growth. Management has said they believe they can at least double their current store base. With mall-based retailers accounting for half of the $40 billion jewelry industry, I believe they can ultimately grow even more than that. Management’s value lies in the fact that they are good at finding locations that will yield high returns on capital and they will continue to do this for shareholders going into the future.

If you look back through their annual reports you’ll find that investment in new stores has been very similar to their FCF; i.e. it costs $0.6mm to open a new store and the number of new stores opened in a given year has been close to (FCF/$0.6mm). Basically, they’ve been using almost all of their FCF to open new stores and achieving ~20% returns on this reinvestment. This should continue when FCF picks back up.

Management Info

Current management has been in place for the last 20 years and in that time they have achieved very high returns on invested capital and transformed Whitehall into a large player in mall-based jewelry. The 6 executives together own over 22.3% of the company. Their interests are very much aligned with shareholders. Management has relatively modest salaries for a company the size of Whitehall(the CEO has $500k in salary and no bonuses) and they have gotten no bonuses or raises in 2001 because of the business's lackluster performance. The current management went through the early-80’s recession and the early-90’s recession. They’ve been here before and they’ve come through both prior recessions in a position to resume their growth strategy. They're currently taking all the necessary steps to come out of this recession as strong as when it started.

I particularly like the fact that management had the brains to see the top of the cycle for what it was. In the beginning of 2000 when sales were rip-roaring they had a secondary offering of 2.3mm shares with proceeds of $42.5mm. By January ’01 they had repurchased an equivalent number of shares but it only cost them $19.0mm. Their savvy netted the company $23.5mm.

Other Info

- Whitehall’s total debt load is highest going into the forth quarter in preparation for the holiday selling season. The CFO says that debt reduction following this years holiday season will be larger than in years past, which will improve their balance sheet and help them to weather the recession.

-It may be a concern to some of you that Whitehall’s same store sales have been dropping faster than many other jewelry retailers. This is because Whitehall mainly sells higher quality merchandise and their ASP is higher than their competition. High ASPs is what has allowed Whitehall to be successful in the past and they don’t plan on making changes to their product line, even if it means tough times in the near term future.

-Whitehall has been aggressively cutting costs at the store and corporate level. This should help to leverage profits coming out of the recession. I’ve used an 11.5% operating margin in this analysis but management believes operating margins could ultimately be higher due to their cost cutting measures.


Whitehall's sales/profits have been getting hurt during the past year and a half, but that is to be expected from a luxury retailer during a recession. Their cost structure and store strategy gives them a sustainable competitive advantage over other jewelers and they have demonstrated this advantage through fantastic returns on capital. I expect future growth to be as profitable as their past growth. I believe this is one of the more attractive opportunities out there and I plan on holding my shares for a long, long time.


An economic recovery will result in a return to historical margins. And the fact that the valuation is pretty silly IMHO.
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