Signet Jewelers Ltd (SIG): Light at the end of the tunnel.

Key Points of Vision

● McKinsey’s analysts are optimistic about the jewelry industry’s future: “Annual global sales of €148 billion are expected to grow at a healthy clip of 5 to 6 percent each year, totaling €250 billion by 2020. Consumer appetite for jewelry, which was dampened by the global recession, now appears more voracious than ever”.

● The US and UK jewelry markets are highly fragmented that implies substantial growth opportunities.

● Much of the catalyst for Signet’s profit growth may come from the cost and revenue synergies associated with the Zale acquisition. The acquisition occurred in 2014. After three months (August 2014), synergies expectations were increased from $100mm to $150mm-$175mm. In February 2015, they reached as many as $225mm-$250mm. Approximately 70% of that cumulative goal is expected to be realized by the end of Fiscal 2017. According to 2016 press release, “Zale acquisition integration progressing well; synergies remain on-target”.

● Signet Jewelers’ stock is extremely undervalued: the upside potential is around 33% (according to both author’s calculations and other analysts’ estimates).

● Signet Jewelers Ltd is a strong, stable and financially sound company: market cap is equal to $6,433.14 million (medium size -> staying power), sales and net income are growing, margins are higher than those of the peers.

● Earnings are growing at a higher-than-average rate:

EPS (MRQ) vs Qtr. 1 Yr. Ago: 25.92. (Industry: -34.36. Sector: -15.35).

EPS — 5 Yr. Growth Rate: 20.41. (Industry: -6.14. Sector: 3.98).

Description of the Сompany

Signet Jewelers Limited is a retailer of jewelry, watches and associated services. The Company operates in the middle market jewelry segment and has number one positions in the U.S., Canada and UK specialty jewelry markets. Certain brands (Jared in the U.S. and Ernest Jones/Leslie Davis in the UK) operate in the upper middle market. Signet Jewelers’ segments are the Sterling Jewelers division, the UK Jewelry division, the Zale division, which consists of Zale Jewelry and Piercing Pagoda, and the Other segment. The Other segment includes subsidiaries involved in purchasing and conversion of rough diamonds to polished stones. The Company operates retail jewelry stores in various real estate formats, including mall-based, free-standing, strip center and outlet store locations. The Company operates approximately 3,620 stores and kiosks across over five million square feet of retail space.

Growth Opportunities

In fiscal 2015, Signet Jewelry Limited (SIG) generated 86.8% of its revenue in the United States. As a consequence, it seems reasonable to concentrate our attention on this market.

● According to the U.S. Department of Commerce, between 2010 and 2015, total jewelry and watch sales in the United States grew at a CAGR (compounded annual growth rate) of 4.4%, reaching $74.7 billion in 2014. Signet Jewelers Limited’s sales demonstrated a more rapid growth with a CAGR being equal to 11.9%. Euromonitor International, a market research firm considering the jewellery sales of 32 countries, states that by 2017 fine jewelry market might have a CAGR of 7.4%. McKinsey’s analysts are optimistic as well: “The jewelry industry seems poised for a glittering future. Annual global sales of €148 billion are expected to grow at a healthy clip of 5 to 6 percent each year, totaling €250 billion by 2020. Consumer appetite for jewelry, which was dampened by the global recession, now appears more voracious than ever”.

● The US (and UK) jewelry market is highly fragmented that implies substantial growth opportunities for its players. Signet Jewelers expanded rapidly through a series of acquisitions in the late 1980s and early 1990s, and nowadays it continues to utilize this strategy. In 2014, the company acquired Zale Corporation, gaining a market share of approximately 15–17% — several times larger than it nearest rival Tiffany. There still is a room for considerable expansion.

● Much of the catalyst for profit growth may come from the cost and revenue synergies associated with the Zale acquisition. The acquisition occurred in 2014. After three months (August 2014), synergies expectations were increased from $100mm to $150mm-$175mm. In February 2015, they reached as many as $225mm-$250mm. Approximately 70% of that cumulative goal is expected to be realized by the end of Fiscal 2017. According to 2016 press release, “Zale acquisition integration progressing well; synergies remain on-target”.

● Signet’s competitive advantages: (i) in-house financing, (ii) size -> purchasing power with supplier: buys many of its goods directly from international vendors at a price advantage compared with independent stores — most competitors, (iii) engagement rings and other pricey jewelry are typically bought in person (lower losses from online competition), (iv) does not strongly depend on the dollar exchange rate — unlike upscale jeweler Tiffany, its stores are not a draw for foreign tourists (at the same time this seems to be an opportunity), (v) dominant marketing/ aggressive advertising campaigns (important, taking into consideration the growing market share of branded jewelry).

Peer Analysis

We have compared Signet Jewelers Ltd (SIG) with the following four companies: Birks Group Inc (BGI), Tiffany & Co. (TIF), DGSE Companies Inc (DGSE), Blue Nile Inc (NILE).

The results of comparison are as follows. Signet Jewelers has certain problems with efficiency. However, at the same time the company is characterized by average/ just-above-average profitability and much-better-than-average growth indicators. Valuation multiples are mostly in favour of Signet as well, implying that its stock can be undervalued.

This is a simple interpretation, which does not take into consideration one important fact.

All of the companies that were chosen for analysis are Signet’s competitors, operating in the same sector. However, an important point is that, though they can be considered Signet’s closest peers, none of them is really close. Birks Group, DGSE and Blue Nile have much smaller size. Their market caps are $58.37mln, $7.89mln and $321.57mln, respectively, while the market capitalization of Signet Jewelers totals $6,433.14mln. In addition, Blue Nile, for instance, is an online specialty retailer, whereas for Signet e-commerce sales account to just around 5% of total sales. As regards Tiffany, it is an upmarket retailer.

These differences have several implications for the results of comparison. Tiffany’s high margins are due to the market segment it operates in, as well as Blue Nile’s exceptional efficiency is not surprising, taking into account its business model. We cannot say that Tiffany and Blue Nile are better managed.

As a consequence, it can be concluded that the actual situation is even better that it can seem.

Financial Analysis

● Sales demonstrated a stable growth, and so did net income.

● In 2016, the net income grew at an accelerated pace.

● SIG saw a sustained increase in total assets; the abnormal rise of 2015 was due to the Zales acquisition.

● At the same time cash and cash equivalents were reducing at an average rate of around 27%. This trend can be considered favourable for the company, taking into account the fact that SIG’s current and quick ratios are much higher than industry’s and sector’s averages.

● The Zales acquisition affected company’s total liabilities as well. Over the period from 2012 to 2016, the value of this indicator increased by 178%,

● However, the immediate past results are favourable: during the last year, both current liabilities and long-term debt experienced a reduction.

Diluted Earnings Per Share (EPS):

Signet Jewelers (NYSE:SIG) last announced its quarterly earnings data on Thursday, May 26th. The company reported $1.95 earnings per share for the quarter, beating the analysts’ consensus estimate of $1.94 by $0.01.

Future Projections:

Valuation

We have found out that the SIG stock may be undervalued. The question arises: what is the fair price per share?

As of July 6, 2016, Signet Jewelers’ market capitalization was equal to $6,433.14 million.

The average growth rate is equal to approximately 33%. SIG stock has a 33% upside potential.

Fair price per share is around $120.

Morningstar analyst Paul Swinand believes the stock is worth $127 a share, more than 50% above the current price. According to CNBC, the median analyst implied upside for Signet Jewelers is equal to 56.3%.

Insiders also seem to believe that SIG stock is substantially undervalued.

Technical Analysis

The long-term perspective appears to be rather clear: the company’s strong fundamentals, solid financial position and impressive earnings results allow us to be optimistic. The question is when/ how soon the current downward trend will reverse and, consequently, should the stock be bought right now or some time later.

As can be the seen from the second chart, there was a descending channel, but the price moved beyond the upper resistance. May it be a false breakout?

On the one hand, little change in volume on a breakout indicates lack of interest and a higher probability of false breakout. However, on the other hand, this break of channel does not look minor/ insignificant (the price crossed 25- and 40-day moving averages) and has already lasted for two days. In addition, at the beginning of June two “exhaustion moves” — sharp moves in price combined with a sharp increase in volume — can be observed.

Taking the above mentioned considerations into account, we tend to believe that the trend did reverse.

Important remark: the TA charts were prepared on July 12. On July 13, the price is continuing to rise (17:40 — day’s range: 88.37–89:90).

Risks

● The retail jewelry market is highly dependent on macroeconomic factors. When the economic situation deteriorates (higher inflation, higher unemployment), jewelry retailers suffer losses. A large share of Signet Jewelers’ revenue comes from engagement rings. As a consequence, the company will, probably, be affected to a lower extent than some of its competitors. And still, changes in the macroeconomic environment should be monitored and analyzed.

● In-house financing is one of Signet’s major competitive advantages, allowing the company to complete more deals by accepting more customers, eliminating its reliance on the financial sectors (and so on). However, at the same time it is associated with a certain risk. The credit business can get complicated. Private-label card loans tend to be the first bill that does not get paid that a buyer-borrower has problems. A good thing is that the credit function can be outsourced or sold. Wells Fargo analyst Ike Boruchow believes that the company can outsource its credit function for 0.9x book value.

● Signet Jewelers’ stock has exhibited a downward trend since the end of October 2015. In addition, the company recently faced negative publicity: (a) BuzzFeed article about customers claiming that diamonds purchased at Signet stores were swapped out for lesser quality stones, (b) James Grant’s investment newsletter raising concerns about the jeweler’s credit operations (using credit to boost sales). The bear market may continue for some time.

Stop Loss of 82 limits the maximum possible loss to 7%.

Conclusion

In the course of our research, we have established the following:

1) Signet Jewelers Ltd is a strong, stable and financially sound company with earnings growing at a higher-than-average rate.

2) Among Signet’s growth opportunities are the overall growth of the jewelry industry, the high fragmentation of the US and UK jewelry markets and the cost and revenue synergies associated with the Zale acquisition.

3) The company’s stock is extremely undervalued: the upside potential is around 33% (according to both author’s calculations and other analysts’ estimates).

4) According to the technical analysis, the bearish trend is already over.

Overall, Signet Jewelers Ltd appears to be an undervalued high growth potential company with healthy balance sheet. The recommendation is to BUY for the long term.