LJ International: A China Retail Play? (JADE)

Hong Kong-based LJ International (ticker: JADE) designs, manufactures, distributes and markets a full range of fine jewelry. A large majority of its revenue is generated in the US where it sells mainly through home shopping networks (HSN, QVC), discount retailers (Wal-Mart, JC Penney) and jewelry chains (Zales). The China connection? In November 2004 the company began opening retail stores in Mainland China and plans a total of 100 by the time the Beijing Olympics arrive in 2008. A number of takeaways from a company presentation at the Westergaard Small Cap Conference in New York yesterday:

China Retail Market

• Estimated sales of $100 billion including $15 billion in jewelry sales.
• Retail jewelry market is fragmented.
• China has huge consumer demand for diamonds.
• Retail sector growing at 15% a year.

JADE's Retail Opportunity

• Expects to open 12-15 retail stores in China by the end of 2005. Next year expect 40 stores and 100 stores within 3-5 years.
• Opening a store in Macau at end of December.
• Expects EBITDA breakeven on retail stores in 2006 and profitability in 2007. Stores expected to break even after a year.
• Shanghai store already breaking even. Average revenue of $80K per month. Each store expected to generate on average $50K per month.
• Operating costs are minimal. Rent is 15-20% of revenue. Other expenses minimal.

Financials

• In two weeks time company will provide guidance for FY 2005 and next couple of years.
• Company expects to beat revenue expectation of $85 million.
• Start-up expenses for retail stores have held down earnings. Excluding start-up costs company has been showing solid growth.
• Management expects revenue of $100 million in 2006.

Valuation

• Hoping the Street will value them as a retail company rather than a manufacturer.
• Retailers typically have 50% gross margins. JADE expects gross margins to grow from 22% to low-to-mid 30s due to retail stores.

Comment: After the presentation the JADE exec answered a number of my questions:

What about reports of Chinese buying most of their jewelry outside of Mainland China where items are cheaper?

• The Chinese are known to buy jewelry abroad. But JADE is positioning itself as a Western brand knowing that Mainland Chinese prefer Western brands. New store in Macau will help with that branding process.

• 40% of the items sold in JADE's retail stores are diamonds. The Chinese are comfortable buying diamonds on the Mainland. Diamonds have become more of a commodity and prices have come down. It is now typical for Chinese to exchange diamonds at wedding ceremonies whereas they previously bought diamonds simply for investment purposes.

Do the Chinese like colored gemstones?

• Not clear that Chinese are yet interested in colored gemstones -- JADE's specialty. That's why 40% of items sold in Mainland retail stores are diamonds. But the company is convinced the colored gems will ultimately sell.

In 2005 JADE regularly revised expectations for the number of store openings. Why? Will that continue?

• The company previously knew nothing about opening and operating retail stores. The company now has a much better sense and does not expect this indecisiveness going forward.

What prevents another company (i.e. Zales) from coming into the market and competing in the same niche?

• Nothing.

Is there an exit strategy?

• The LJ exec admitted that a sale to Zales (she specifically cited Zales) or a spin-off of the retail units could very well happen in the future.

Related:

• All China Stock Blog articles on LJ International.
• A list of full conference call transcripts available on the Seeking Alpha Network.
• The complete list of China stocks (and links to articles about them) covered by The China Stock Blog.

JADE chart.