Zale Still Sparkles Despite Slowdown; Emulex a Dizzying Ride

Zale (ZLC) Jim: Buy

Mike: Buy

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Jim: Our two stocks today both got knocked silly recently, Mike, which no doubt prompts many investors to wonder whether the shares might now be a buy on the premise that the bad news is out of the way.

Mike: Except that these situations always beg the question: Is the bad news really out of the way? Sometimes bad news begets more bad news.

Jim: Where there’s smoke there’s fire.

Mike: Or a smoke-making machine. Anyway, at Zale Corp.--started by the Zale family in 1924 and now the nation’s largest jewelry retailer--the news was twofold: its chief executive, Beryl Raff, resigned after just six months on the job; plus, Zale’s sales over the holidays were lousy.

Jim: Not that Zale was alone. Retail sales in general were poor over the holidays, and they were especially bad for purveyors of fine jewelry.

Mike: I think of Zale as the General Motors of the jewelry business, because its 2,300 stores are divided into various brand names that appeal to different markets. Zales itself is the Chevrolet for middle-market customers. . . .

Jim: Incidentally, for all our grammarians out there, it’s “Zale” the parent company, but the stores are routinely called “Zales,” and even the parent advertises them with that spelling, with no possessive apostrophe.

Mike: That’s British usage, by the bye. Now, as for the other Zale names, there’s the Gordon’s chain, which is like, say, GM’s Buick. And if you’re feeling really flush and think you’re in the Cadillac class, there’s Bailey Banks & Biddle Fine Jewelers. Between them Zale probably owns half the jewelry stores in South Coast Plaza.

Jim: And they’ve all been hurt by the slowing economy. Even the wealthy have cut back, because Tiffany & Co. also had a disappointing fourth quarter of 2000.

Mike: I’m not surprised. We talked about Tiffany a while back and warned that if the economy flattened, it and other sellers of discretionary goods would feel the pinch first.

Jim: OK, so everyone’s hurting. But one has to wonder whether the resignation of Raff just a week ago sends up a red flag that there are internal problems unique to Zale.

Mike: Really? According to what I read in the papers, Ms. Raff quit as head of a major jewelry company to devote more time to her family--to drive carpool for her school-age son, things like that. Are you telling me you don’t buy that?

Jim: Let’s just say I figure there’s more to the story.

Mike: You, you skeptic.

Jim: Raff was succeeded by the man she had replaced, Robert DiNicola, who won plaudits for taking over the Irving, Texas-based company in 1994 after it emerged from bankruptcy and then turning it into a real money maker.

Mike: You know, I’m always fascinated when a company’s board, facing tough times, turns back to the old days--much like the Russian people in the throes of their agony sometimes wish for the return of Stalin. I’m not saying that Mr. DiNicola is Joe Stalin, but clearly the board is hoping he can work his magic again.

Jim: Or at least restore order. Right now, Zale’s stock is trading for only 10 times the per-share profit the company is expected to earn in its fiscal year ending July 31.

Mike: Now, on the premise that the stock market has predicted only five of the last 10 recessions but accurately anticipated every one of the economy’s last 10 recoveries, I’m inclined to believe this stock will rally before the company and the economy rebound. Therefore I call it a buy.

Jim: Really? Me too. I think the economic slowdown we saw during the holidays was priced into this stock months earlier, which is why Zale shares drifted lower for the last six months of 2000. Yet right after Christmas, the stock was rebounding smartly. . . .

Mike: Until the day Ms. Raff decided that she needed to go home and feed the dog. By the way, in all fairness, it seems Ms. Raff may simply have been in the wrong job. By all accounts she was a superb marketing and sales executive but may not have been cut out to be CEO.

Jim: Right. Now, there’s no question this stock would be a speculative buy. Last week, as the firm announced Raff’s departure, it also said it would delay the release of its fiscal second-quarter earnings until March 7. That’s another red flag.

Nonetheless, I too expect Zale to regain its momentum later this year. And long term, its diversity among different market segments appeals to me.

Mike: Agreed. DiNicola’s return also is a positive sign. And with the stock’s low price-to-earnings ratio, it’s that much cheaper to buy into his proven track record.

Emulex (EMLX)

Jim: Don’t Buy

Mike: Buy

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Mike: Our second stock today is Emulex. . . .

Jim: Which just can’t seem to keep itself out of the papers.

Mike: That’s right. This is certainly an exception to the old saw that there’s no such thing as bad publicity as long as they spell your name right.

Jim: Emulex is on Harbor Boulevard in Costa Mesa, which puts it not very far geographically from Disneyland.

Mike: Yeah, though I don’t think Disneyland would dare to install a ride that looked anything like Emulex’s stock chart over the last year, unless it was determined to build the scariest roller coaster in the state.

Jim: First, let’s talk about what this company does.

Mike: Sure. Emulex produces fiber communications products that help companies improve their data storage by giving them a high-speed way to move that data around. Let me just say I think this is a great business to be in.

Jim: Wouldn’t you agree this is part of the computer networking infrastructure industry that we’re always saying is a good place to invest?

Mike: Yes and no, because although the market is sure to grow, these stocks can be very volatile.

Jim: They generally carry very high price-to-earnings multiples.

Mike: And Emulex, in particular, has had, er, a colorful history.

Jim: In only the last nine months!

Mike: Indeed. Let’s go back to August. Emulex was victimized by a spectacular hoax in which a college student fabricated a news release purporting to be from the company and persuaded an otherwise reputable news service to publish it. Among other things, the release said federal regulators were investigating the firm’s accounting.

Jim: Emulex lost more than half its market value that day, though it quickly gained most of it back after the hoax was exposed.

Now, last month Emulex reported fiscal second-quarter results, and they were very impressive. For the six months ended Dec. 31, revenue more than doubled and operating earnings nearly tripled.

Mike: Unfortunately, when you’re trading at a price-to-earnings multiple of nearly 130, some people are never satisfied.

Jim: That’s right. Three weeks later, Emulex followed that earnings report with a warning that some of its customers, which include major companies in the data and networking fields, were deferring orders because their own customers were deferring orders to them, in a long daisy chain of cutbacks in corporate capital spending.

But rather than use the common method of simply putting out a news release with the negative information about its sales growth, Emulex first put the news on its Web site. So a lot of people didn’t realize what was coming.

Mike: Exactly. As the stock suddenly plummeted, Emulex’s investors could only hope that the sales warning was a hoax too. But it wasn’t, and the shares once again lost more than 40% of their value.

Jim: And we’re not talking about a penny stock here. This is a stock that basically went from $80 to $40 in a single day.

Mike: It’s just under $40 now. And I don’t think it’s going to recover in a day or two this time.

Jim: No. I wouldn’t buy this stock because, given the company’s near-term prospects in the wake of its sales warning, I think the price is still too high. It’s trading for 45 times what the company is supposed to earn per share in its fiscal year ending June 30. I think that’s pretty dear.

Mike: Do you?

Jim: Yes. It’s about double the P/E of the market overall.

Mike: Well, that broad market includes Lucent Technologies, Xerox and a lot of other burned-out hulks.

Jim: I’m aware of what the broad market includes, Mike. You like this stock?

Mike: Well, I don’t dislike it. I expect a wild ride ahead. And I suspect Emulex is now getting a very wary eye from a lot of investors who aren’t too thrilled about the way the company announced its sales slowdown.

Even so, I look at Emulex’s stock chart and I say the price is poised for a rebound, on the principle that almost all the networking-infrastructure stocks have now been pounded down severely by investors. Yet this is still a great industry for the next few years.

Jim: Sorry, but Emulex hasn’t been pounded down enough to a price where I would buy it, though I don’t entirely disagree with your outlook.

Mike: Just more than 50%.

Jim: By the end of this year orders for this kind of networking gear should pick up again. Emulex has strong prospects longer-term. I just think the stock is overpriced at this level.

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Mike: And now, Jim, it’s our bittersweet duty to inform our readers that this is our last column.

Jim: That’s right, Mike. Since we started these fireside chats almost three years ago, I hope we’ve succeeded in giving our readers a good sense of the art, as well as the science, of investing. But as all good things must come to an end, so too must Stock Exchange.

Mike: Indeed. Although I know many of our readers, as well as our editors, have felt we’ve had a great run, it’s time for both of us to move on to new things here at The Times. Now . . . you’re going home to feed the dog, right?

Jim: And you’re helping your kids with the carpool?

Mike: If the traffic’s not too bad tonight. Adios.

Jim: Adios.

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Peltz ([email protected]) covers the markets and corporate financial trends. Hiltzik ([email protected]) covers technology and entertainment.

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Emulex Corp.

Friday: $38.06

Zale Corp.

Friday: $32.80