Description

Finlay is the dominant operator of leased jewelry departments in major department stores (Bloomingdale's, Marshall Fields, Dayton's, etc.) with more than 1,000 locations in the U.S. Department stores outsource their jewelry departments to Finlay due to Finlay's expertise in buying, selling, and promotion, which has allowed the company to report comparable department sales growth well in excess of their host's comparable store sales. While "Finlay" is certainly not a household name, the company can leverage the host store's brand name (for example, a necklace might come in a Bloomingdale's gift box) and leverage the host store's traffic. The economics of opening a location is quite attractive: capital expenditures of $75,000 and net working capital of $200,000 will yield approximately $900,000 in revenue and an incremental profit contribution of $130,000; thus, a new department might have a payback of 2.1 years.

The company's guidance, prior to the September 11th tragedy had been for revenue of $970MM and eps of $2.10 - $2.15 for this year (FY ends in Jan 2002). In addition, the company has $0.25 per share of goodwill amortization, so "cash earnings" would have been $2.35 - $2.40 per share. This guidance reflected a weak consumer spending environment (guidance earlier in the year had been considerable higher), so the shares trade at about 3x what the company anticipated earning in a poor year. However, September comparable store sales were down 9%, and the events of September 11th will probably make it very difficult for the company to achieve this year's goals. Fortunately, Finlay has a relatively flexible cost structure: many of its workers are part-time employees (especially during peak selling seasons) and lease payments to department store hosts are variable (because they are a function of revenue generated).

As the result of a 1993 leverage buyout by Thomas H. Lee and acquisitions of several competitors (Finlay has now acquired all of its major competitors), Finlay's balance sheet is quite leveraged with net debt of approximately $300MM, equity of $130MM ($12.60 p/s), and tangible equity of $40MM ($3.80 p/s); since the debt primarily finances inventories, which were $320MM versus net fixed assets of $70MM, management can lower its debt levels through inventory reduction. With no major competitors left to acquire, I would anticipate that Finlay focuses on deleveraging its balance sheet (although the company also has been using its authorization to repurchase shares).

Catalyst

FNLY shares have been very weak due to expectations of weak consumer spending (especially after the events of September 11th) and now sell at very depressed levels. After completing several acquisitions of all its major competitors, the balance sheet should improve significantly over the next few years as the company focuses on reducing debt.