Glowing With Profits

Investors may still have the urge to get into small cap stocks, because they are leading the market in 2013. While the run to all-time highs by the Dow Jones Industrial Average and the S&P 500 have dominated the headlines, the small-cap Russell 2000 has them both beat.

Year to date, the Russell 2000 small cap index is up 20.75 percent, compared to 17 percent for the S&P 500 and only 16 percent for the Dow Industrials.

Investors eager to move into small caps at this stage should look at those with improving sales and earnings that are still trading at a reasonable valuation. One choice is specialty diamond and jewelry retailer Zale Corp (NYSE: ZLC). The company achieved earnings growth of 59 percent last quarter and is projected to grow 45 percent in the next year.

Zale Corp reported in the second quarter its highest annual net income in six years. Net earnings were $10 million, or $0.24 per share, compared to a net loss of $27 million, or $0.85 per share, in fiscal year 2012. Zales has continued to increase revenue in recent quarters as its efforts to raise prices, improve core inventory and roll out new branded products appear to have helped lift same-store sales.

For the quarter ended July 31, overall same-store sales rose 5.6 percent, slower than the 8.3 percent rise logged in the year-earlier quarter. Same-store sales at Zales branded stores climbed 8.1 percent, while those at Peoples branded stores were up 5.6 percent, or 7 percent at constant exchange rates.

Same-store sales for U.S. fine-jewelry brands increased 7.2 percent. Canadian Fine Jewelry brands, consisting of Peoples Jewellers and Mappins Jewellers, reported a same-store sales increase of 3.3 percent, or 4.7 percent in constant currency. Kiosk jewelry same-stores sales edged up 0.3 percent.

For fiscal year ended 2013, Revenues were $1.89 billion compared to $1.87 billion in fiscal year 2012. For fiscal year 2! 013, comparable store sales increased 3.3 percent. This increase follows a 6.9 percent rise in fiscal year 2012. At constant exchange rates, comparable store sales increased 3.1 percent.

Zales branded stores, consisting of Zales Jewelers and Zales Outlet, posted a comparable store sales increase of 4.7 percent. This increase follows a 10.8 percent rise in the prior year.

Zales is benefiting from their store technology enablement program that was kicked off during fiscal 2013. This technology modernization will provide the backbone for stores to leverage the tools and capabilities to improve inventory control, increase customer experience and sales.  Zales is currently completing phase 1 of the program.

By mid-September, over 300 of their stores will utilize a new POS system, both hardware and software; high-speed broadband; and Wi-Fi capability connected to a state-of-the-art secured network. The remainder of stores will be similarly enabled during 2014.

Following this, Zales will aggressively roll out tablets to stores and enable jewelry consultants to participate in the benefits of omnichannel commerce.

The market has rewarded Zales with an astounding 230 percent increase in 2013. While the stock’s price-to-earnings (P/E) ratio is high because the price is ahead of profits, the stock has a price-to-sales ratio of only 0.25. The stock trades at 2.2 times its current book value, which is reasonable for a high growth small cap stock.

Zales is projected to grow earnings by 45 percent in the next year. This will be accomplished with increasing sales and higher pricing as the consumer increases spending on specialty jewelry in an improving economy.

First Call consensus has a strong buy rating on the stock. Zale Corp has a 12-month price target of $17.50.

Greg Pugh, an income-investing expert, publishes a newsletter called Investing for Monthly Income.