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Friday, September 3, 2010

Healthy Luxury Market? Harry Winston (HWD) Says Rough Diamond Prices Above Prior Peak; Provides Glimpse of Earnings Power

Shares of Harry Winston Diamond Corporation (HWD) caught a bid yesterday following better than expected earnings results for the company's fiscal 2011 second quarter (end July). From Google Finance:

We last mentioned Harry Winston in our July post, Perspective on Consumer Trends Around the World from Estee Lauder and Harry Winston. As indicated in that post, we did slightly reduce our HWD stake for reallocation into relatively unloved names - including more Seaspan (SSW) and Global Ship Lease (GSL). However, we still hold the majority of our original position in Harry Winston and see incremental upside based on normalized earnings power.

What is normalized earnings power? Fair question with many moving parts that create a range of possible outcomes. The good news is that July quarter results -- EPS of $0.18 excluding a $0.04 foreign exchange benefit -- provided a hint of the company's earnings potential. Now, the Street is ratcheting forecasts upward. Assuming fundamentals keep moving in the right direction, earnings power should become more evident over the next year.

Just how are fundamentals? Another important question. Here are top-line and operating earnings highlights directly from the press release:
Consolidated sales increased 62% to $153.7 million from $94.8 million
in the comparable quarter of the prior year, resulting in earnings
from operations of $28.9 million, compared to a loss from operations
of $3.9 million for the same quarter of the prior year.
- Rough diamond sales rose 89% to $86.8 million from $46.0 million in
the comparable quarter of the prior year. The increase in sales was a
result of a combination of a 62% increase in rough diamond prices and
a 17% increase in volume of carats sold during the quarter.
- Retail sales increased 37% to $66.9 million from $48.8 million for
the same quarter of the prior year. Sales in Europe increased 40% to
$24.7 million, sales in Asia increased 40% to $22.6 million, and US
sales increased 31% to $19.6 million. Earnings from operations of
$2.3 million for the quarter compare favorably to a loss from
operations of $5.6 million, in the same quarter of the prior year.
Moreover, several key points from Q&A on the conference call stood out to us, which we share here to not only relay the Harry Winston story, but also for excellent perspective on trends in the global luxury market and economy. Thanks to SeekingAlpha.com, we have the following:

On sharply higher merchandise inventory for the retail operation:
  • Bob Gannicott, Chairman/CEO: “It's up for very good reasons. We have a very significant pipeline of high jewelry sales at the moment. It's very significant. It's probably more significant than we've had since I've been with the company. And that inventory has been purchased to support largely this pipeline.”
  • Irene Nattel, RBC: “How very interesting. Thank you.”
We agree with the analyst: "how very interesting" and bodes well for upcoming results. Note that Mr. Gannicott was appointed the President and Chief Executive Officer more than a decade ago, in September 1999, although he's been a director since 1992. We presume he's talking about his management role that began in 1999.

On higher rough diamond prices for the mining operation:
  • Des Kilalea, Royal Bank of Canada: “…I think Bob you said last time that you thought prices were about 5% or 10% below peak… Where would you put prices now versus the end of 3Q08?”
  • Bob Gannicott: “We've gone past the peak, by a measurable margin. The only thing is … it's sort of become somewhat uneven. Thankfully, our production is very focused in value from white goods, typical Canadian production. Obviously, the appearance of large volumes of production from Zimbabwe has held back the price increases and in fact probably depressed prices somewhat in smaller, cheaper, off-color goods. So, for our average production, we have gone past the peak that was achieved before the recession.”
Rough diamond prices for Harry Winston Canadian production higher than the prior peak = excellent news.

AND, finally, on demand for "significant pieces" -
  • Frederic de Narp, President and CEO, Harry Winston Inc.: “First of all, I think the wealthy people of the world are growing. In 2009, taking statistics of Merrill Lynch or Capgemini, the ultra-high net worth in the world grew by 19.6% and the high net worth has grown by more than 17% in '09... So there are more wealthy people around the world.
  • Second, it is true that in this volatile world we note that people would rather spend a million dollars on a necklace for the person they love as an investment. Said investment is a glamorous investment, something that they can enjoy instead of some other investments that they don't really know. Also because unique stones and unique pieces have proven to be extremely profitable and the price has been growing tremendously during the last five years.
  • And last, it's a moment where people do not hesitate to celebrate the meaningful moments of their life, investing in some authentic, true value, craftsmanship pieces, and this is what Harry Winston stands for. So we have an offer and we have a brand position and we do with that correspond exactly, precisely to this quest for authentic, unique pieces that people want. So we see it growing exponentially and growing for the next quarters, and growing as a trend…”
So, the global population is wealthier, more people purchase diamond jewelry as an investment, and Harry Winston is a premium, well recognized brand.

The results and commentary illustrate ongoing global shifts in purchasing power and the importance of owning businesses with international exposure. They also reveal the benefit of owning a business that holds a 40% interest in a highly coveted asset -- some of the highest quality diamond deposits in the world. From the company's July presentation:

Harry Winston is not without risk -- the Diavik Diamond Mine is located in a remote part of Canada and is the company's only mining asset -- yet we continue to sleep well owning a piece of the business.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long HWD, SSW, GSL.

© 2010 Jeffrey Walkenhorst
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