Steve Katz:
Hi, everybody. And thanks for taking time out of your busy schedules to listen in to our Hilco Global Smarter Perspective podcast. As return listeners know by now, I'm your host, Steve Katz. And if this is your first time with us, well, then welcome. We're glad that you could tune in.
Steve Katz:
Our discussion today is centered around a number of factors that are influencing current performance in the jewelry industry. And we'll be providing some thoughts on lender monitoring as well as considerations regarding procurement, inventories, and NOLVs in the current market as well. And here with us to talk about all those things today is a return guest and jewelry market expert from Hilco Valuation Services, Stephen D'Aquila.
Steve Katz:
Stephen, welcome.
Stephen D'Aquila:
Thanks, Steve. Nice to be back and have an opportunity to come back on the show to speak with your listeners on an update on the jewelry market.
Steve Katz:
We're glad to have you back on. It was really interesting last time around. So, let's jump into it.
Steve Katz:
First of all, I'm thinking it would be good to do just a relatively quick level set on market performance through the end of last year. And then we can talk about what you and the team have observed so far over the first couple of quarters in 2022.
Stephen D'Aquila:
Sure thing. So, when you look at last year's cumulative jewelry market results, I think it's also important to look back to the comparable period in the prior year back into 2020. So, at the start of the pandemic, the jewelry sector, like most industries, initially experienced a period of great uncertainty. Concerns about personal economic situations, individuals had general health conditions. The vast majority of the consumers are transitioning away from discretionary spending in favor of really bolstering their savings accounts. Now, at the same time, their shopping habits are also shifting. Going more from brick and mortar over to eCommerce-based shopping. Now, this is a trend that has been experienced for a number of years now but has really exacerbated with the pandemic itself. So, with that, this has a negative impact on many jewelers given the higher price point and discretionary nature of the items that they sell coupled with the historically higher concentration of brick and mortar sales for the jewelry industry in general.
Stephen D'Aquila:
What we found is that jewelers that had a higher eCommerce penetration rate, particularly leading up to the pandemic and prior to the pandemic, favored better than their traditional brick-and-mortar peers. Now you fast forward to the second half of 2020 and the tide began to change a bit. You have unemployment levels that were beginning to fall down. You have increased savings levels, lower interest rates, stock market that has really been going on a dramatic rebound from its March 2020 lows, and government stimulus initiatives that all created additional spending capacity for consumers in many sectors including jewelry. So, jewelry revenue growth was aided by a redirection of consumer spending away from these pandemic-restricted areas, think about travel and entertainment spend, and in favor of merchandise that included the jewelry sector. So, now you move into the first half of 2021 and the benefit H1 of 2021 received was they had a low bar, a hurdle rate that was very low in comparison to the 2020 H1 results.
Stephen D'Aquila:
Second half of 2021 sales had a more challenging hurdle now because now they're comping up against strong performance in the second half of 2020. But overall, if you look at it on a trailing 12-month basis for 2021, performance was generally strong. The stock market continued its climb from its lowest set in March 2020. So, rising stock market through 2021 really benefited consumers most notably in the higher economic brackets. Then you have historically low-interest rates and a red-hot housing market. Those coupled together also disproportionately benefits those concentrated in that upper-income level. So, these factors together, and then you couple in low unemployment and a higher than historical average wage growth, that leads to a rise in consumer confidence throughout 2021, which benefits the jewelry sector in addition to many other sectors. And overall, we found that the higher-end jewelry sales outpace that of more entry-level price points within jewelry.
Steve Katz:
Yeah. So, that's a really helpful synopsis. Think that it helps provide the context that I was hoping for as we dig into it a little bit further, talk about where the industry's headed, and as we near that mid-point of 2022 right now. So, what are you and the team seeing at this point in time and what challenges do you see facing both those higher-end and lower-price point jewelers this year?
Stephen D'Aquila:
So, right now we're about six months into 2022 and there's obviously a general degree of economic uncertainty. It's sweeping across not only this nation but across the rest of the world. And that's really driven by international conflict. You have inflationary pressures that are really at historically high levels and you have a declining stock market. You put all these trends together, it's going to impact general borrow performance and appraise liquidation values. So, what we do is we're really looking at, specifically within jewelry, how this is impacting varying price point jewelers. So, what I like to do is just separate the market into two different sections, one being the higher-end jewelers and the second being lower-price point jewelers. So, we start with the higher-end jewelers, customers in this segment, they're less affected by inflationary pressure and commodities such as food and fuel.
Stephen D'Aquila:
The area that you want to pay attention to is more general stock market performance. I look at the VIX, for example, general consumer sentiment, changes in interest rates in the housing market trends. All of these factors can influence overall buyer behavior. If you have unfavorable movement in these areas, that generally creates a distraction for these types of customers, which creates overall volatility in the financial performance of the jeweler borrower. If you look at the lower price point jewelers, on the other hand, this segment should really focus on how everyday consumers are responding to changes in living costs, which are impacted by inflation. So, if you look at areas such as rent, food, energy costs, for example, how those impact overall spend and subsequently their personal savings rates. That will in turn impact how the jewelry sector will perform for a lower price point jeweler.
Steve Katz:
Makes sense. Good. I think that's a good way to separate it out into those two categories as well. So, you touched on this earlier. There's clearly a lot going on in the world that's affecting industries across the board right now. So, when we look at the continued influence of things like COVID 19, the war in Ukraine, and the supply chain, which seems to be a never-ending concern right now. And when we look at all those through the lens of the jewelry industry, specifically, what types of impacts are you observing?
Stephen D'Aquila:
So, I'll start with the COVID 19 pandemic. This pandemic continues to evolve for the last couple of years now. And it's evolving, not just in the United States, but across the rest of the world. New industries such as travel and entertainment really were negatively impacted at the start of COVID 19 because of various restrictions. But those restrictions have since lifted and spend is being redirected to travel entertainment and away from areas such as merchandise spending including jewelry. You have lockdowns in areas such as Shanghai, China with a zero COVID policy in place. That's impacting how those consumers are able to shop and spend in that part of the world. So, as jewelry begins to compete further for share of wallet with other high-ticket items, the corresponding impact on jewelry sales should really be monitored. And any continued COVID 19 outbreaks should be monitored in different parts of the world.
Stephen D'Aquila:
For example, beyond China, you have semiprecious and precious stone supplier regions such as India with loose diamonds and Thailand with gemstones. Those countries should also be monitored. When it comes to Ukraine, Russia invaded Ukraine and we're still seeing the impact that this invasion has created and the general uncertainty that has evolved for the global economy as a whole. So, there are sanctions on Russian products and areas related to lending to Russian companies, which really should be monitored by the lender and then how that will impact the jewel or borrower that is with your particular client. Russian-owned diamond powerhouse, Alrosa, this company supplies roughly 25 plus percent of the overall diamond market globally. They operate in 10 countries and three continents. So, when you see changes in supply related to this company, it's important to understand what type of exposure the jeweler borrower that you might be working with has to this particular company.
Stephen D'Aquila:
And it's not just a direct exposure. It could even be exposure related to the fact that now that the supply chain is shut off from this company, are there other vendors that are being impacted by changes in demand and supply because of this? So, what you would want to do as a lender, you would want to monitor how diamond pricing and availability changes going forward through the rest of 2022. And we're expecting diamond pricing to increase, regardless of if the conflict ends today, for example. The lender should also monitor changes in beyond diamond pricing, both were often polished. Should also monitor the borrower strategy regarding the customer pricing of the product itself. In addition to that, traceability of diamonds is also important to look at, specifically, are goods coming from Russia, and are the jewelers' customers requesting traceability on a particular product? We saw this back when there were blood diamonds in the past and consumers were concerned about having a diamond that was considered a blood diamond. So, it's possible that this will also impact overall availability of products going forward.
Stephen D'Aquila:
From the supply chain side, jewelry, specifically diamonds, they're low cube and they're high value. So, unlike many other industries that were negatively impacted by rising freight costs and supply chain disruption, jewelry is a bit more insulated. This type of product is generally air freighted in opposed to being sent in by vessel. And so, while all transportation modes have experienced an uptick in overall freight costs because diamonds are low cube and low weight, and high value, these items generally experience greater expansive absorption in comparison to other product types. Unlike diamonds and other finished good jewelry, an area that you would want to watch out for is the actual packaging related to the goods themselves. So, this could be presentation boxes or pouches. These are items that are generally import goods and they're imported via vessel cargo. So, areas such as transit time, container costs, and general packaging availability are areas that I would recommend taking a look at in terms of how that may or may not impact the borrower currently.
Stephen D'Aquila:
In addition to that, if you have a brick and mortar retailer and they're opening up new storefronts, the ability to receive in fixed string for the stores, such as display cases or lights, for example, there may be a delay in receipt of those items, which will then impact the client's ability to open up storefronts in our according to plan.
Steve Katz:
Okay. Very interesting. On a more upbeat note, am I right when I say that there's also been a big uptick in the number of weddings that are being booked right now? I feel like I've been hearing that more and more over the past few months and I would imagine that something like that would bode really well for the industry overall.
Stephen D'Aquila:
I actually saw that stat not too long ago. I was looking at different wedding planner sites and noticed that, according to experts, there is expected to be around 2.5 million weddings that will occur domestically in 2022. That rate is the highest rate that it's been in several decades now. And to your point, there is a benefit. When there are more weddings, there's a favorable impact to jewelers. So, you have engagement ring sales coupled with bridal band sales. With this increase in overall wedding engagements, that will favorably impact overall jeweler retail results. So, what we're doing is we're currently looking at how that behavior is changing as more venues are opening up and more people are becoming engaged or are getting married and how that's impacting overall ring sales activity. And we look at that in comparison to how price points are also changing.
Stephen D'Aquila:
So, how does a consumer respond to a higher diamond price, a higher ring price, for example? Are they willing to pay the extra money for the liked product or is there a trade-down of impact that's occurring? So, those are areas that we recommend that the lender monitors with their potential client. In addition to that, the ability for a particular borrower to be able to transition a one-time customer into a repeat customer in the jewelry industry is something that's very important to create, what I would call, a customer for life. So, if an individual comes in to buy an engagement ring for their fiance, do they have the ability, the store, do they have the ability to then take that customer and bring them back in to sell them the bridal rings? Do they then have the ability to take that customer and bring them in to sell them, in the future, fashion-type jewelry? Or in the future, can you get them into an upgrade program of the center stone of the diamond engagement ring for a higher price point item?
Stephen D'Aquila:
So, all these factors collectively are areas that we would recommend that the borrower, as well as the lender, track to manage or understand active customer activity as they're a higher lifetime value than a one-off type customer. And that's also going to impact how we would market our sale event in an actual disposition strategy. So, things like customer listing, customer count, average transaction size, and frequency of transaction, these are all areas that I would monitor. And then when we talk about weddings, I think it's also important to also talk about precious metals and diamonds and how they have trended price point-wise. So, if you look at gold, silver, and platinum, they generally following a similar trend over the last several months. They rose from a low level in January 2022 to really a high point as of March 8th of 2022. Gold in general is viewed as a safe haven investment.
Stephen D'Aquila:
So, if there's economic uncertainty or the stock market is faltering, investment flocks to gold because it performs in an inverse fashion as compared to the stock market. But what's interesting is more recently as the stock market's fallen off driven by rising inflation and the federal reserve raising interest rates, what we're also noticing is that it's influencing gold pricing. And instead of investors favoring gold during the period of rising inflation, we're finding that investors are flocking to other asset classes such as real estate, for example. It's interesting to see that it's come down several hundred dollars. It reached a high point of over $2,000 announced on March 8th and it's currently trading around $1,850 an ounce. So, it's come up slightly but it's still around the $1,850 mark.
Stephen D'Aquila:
Loose diamonds, on the other hand, when you look at Rapaport, which is an industry diamond pricing source, the average loose diamond prices increased over 17% for a one carat and almost 19% for three-carat stones when comparing 2021 to 2020. The smaller stones, on the other hand, that third of a carat, a half a carat stone, have remained relatively unchanged. You can see that general supply chain shortages on the rough side coupled with increased consumer demand are really driving up the larger stone diamond pricing in general. And we're really noting and expect continued price appreciation throughout 2022.
Steve Katz:
There's a lot of interesting things in there, obviously, but that shift away from a preference for gold during an inflationary period is kind of interesting. Obviously, what was going on in the real estate market for a while with the low-interest rates probably played into that. But it will also be interesting to see with the rates up now, what will happen with that. So, very interesting.
Steve Katz:
I'm assuming that like the rest of the industry beyond the cost of goods, operating costs are also going up for jewelers as well during this inflation period. Is that correct?
Stephen D'Aquila:
That's what we're seeing. First off, payroll. You're seeing this across the board in whatever sector that you're looking at. And the lack of work or availability, general wage inflation is placing pressure on many companies, jewelers included. In addition to that, you have positions such as sales representatives, cutters, and gemologists. These are all trained positions that have different skill sets as compared to general retail or distribution employees in other industries. So, that makes it a little bit more difficult to attract the correct talent for the positions needed. So, that is something that really should be monitored. The company's ability to attract and maintain the talent that they need to conduct their business. In addition to that, increases in historical payroll rates, which influence the inventory appraisal liquidation expense structure for retained positions in a sale. So, that's obviously going to hit the [inaudible 00:15:46] and really should be monitored.
Stephen D'Aquila:
Secondly, you have advertising. Digital advertising and pay-per-click type performance advertising spend. This has experienced period of material inflationary growth from a cost perspective throughout 2022. So, this is an area that we really believe the lender should be monitoring actively in terms of the borrower's advertising approach, including advertising mediums that they utilize. A specific pay-per-click, the lender should be monitoring the profitability at a detailed level, the pay-per-click services. And changes in borrower's historical advertising run rates, that will influence the liquidation expense structure in an appraisal analysis. And then for eCommerce companies, advertising expense impact is generally magnified.
Steve Katz:
All right. Well, tremendous information. Really appreciate all the thoughts. Any last items you wanted to share with listeners today on steps that they should take or cautionary lookouts headed into the back half of the year?
Stephen D'Aquila:
Sure. As you can tell, there definitely is a degree of volatility in the market right now, which increased recently. They're both favorable and unfavorable influences on performance currently for many of these borrowers. I think the point that I would just like to make is to really make the listeners aware that they're always welcome to reach out to me now or in the future if they would like to discuss an existing or even a potential new credit facility.
Steve Katz:
All right. Well, thanks for those insights and for joining us. And what's the best way for listeners to get in touch with you?
Stephen D'Aquila:
You can reach me by either email or phone. My email is sdaquila@hilcoglobal.com And my phone number is area code (857) 204-2841.
Steve Katz:
All right. Well, thanks again. And listeners, if your business or a business in your portfolio is involved anywhere along the jewelry industry supply chain, I would definitely consider reaching out based on the contact information that you just heard. Things remain volatile right now. And I know that the team here at Hilco is having conversations every day with clients and contacts across the industry, which gives them added insights that could very well help you in your efforts moving ahead. And as always, we hope that this Smarter Perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. And remember, you can check out more podcasts and articles featuring timely insights by Hilco experts at hilcoglobal.com/smarter-perspectives.
Steve Katz:
Until next time, for Hilco Global, I'm Steve Katz.