Today’s note includes the Signet Jewelers’ (SIG) earnings update and our price target increase, as well as our ratings changes from this past Monday, and the podcast.
Earnings updates
Signet Jewelers (SIG) – Under its previous leadership, Signet suffered large losses in its in-house credit operations after using easy credit terms to boost sales, neglected to update its merchandising and marketing, had an ineffective ecommerce strategy and tolerated a toxic culture. New leadership is making impressive progress in reversing all of these problems as it overhauls every aspect of the company, and making the company much more relevant, profitable and valuable.
The company reported what can only be described as a “blow-out” fiscal first quarter 2021 earnings compared to ours and the market’s expectations. Earnings of $2.23/share (refreshingly for a public company, there were essentially zero adjustments) were 76% higher than the consensus estimate. A year ago, the company produced a large loss, and two years ago Signet earned only $0.08/share on an adjusted basis.
Revenues of $1.7 billion were nearly double the year-ago revenues (not meaningful due to the pandemic) and +18% compared to two years ago when the company had 16% more stores. Revenues were about 4% higher than the consensus estimate.
Perhaps just as encouraging, Signet raised its full-year operating earnings guidance by nearly 50%. Clearly, the turnaround is working exceptionally well as the leadership has aggressively overhauled the company’s entire business, recently helped in part by generous government stimulus checks and tax refunds flowing to customers and a post-pandemic surge in weddings.
The success that the company is having with its turnaround is remarkable and rare. Sales are growing because Signet is offering the products and related services that customers want. The company is capturing an array of recent trends and underlying preferences that previously were ignored, and is aggressively expanding the reach and productivity of its retail, digital and social media channels. It is able to offer more merchandise, and more relevant merchandise, at more attractive prices than before, yet huge and structural improvements in data analysis and logistics are allowing the company to maintain sharply lower inventory levels (down 19% in the quarter despite the sales growth). Its services build-out now includes 700 on-line consultants to help customers find what they are looking for. Management gave an example of how all this can work: a customer requested, via the website, a next-day custom engagement ring, which Signet’s consultant was able to find, customize and deliver on time for a $25,000 sale.
One intangible is that Signet’s digital/social media upgrade may be polishing up some of the reputational tarnish of its mall-based stores, such that new customers in prime, higher-income demographic groups are now comfortable with buying from the company. The 15% increase in average transaction value for its U.S. operations may reflect this upgrade.
Importantly, Signet recently signed a new customer credit agreement with two long-term partners at more attractive terms.
Signet is producing generous free cash flow (probably $200 million+ this year). Cash is piling up on the balance sheet (now at $1.3 billion) and is nearly twice the $800 million in debt and convertible preferred shares. Signet reinstated their quarterly dividend at $0.18/share, which would produce a 1% yield on today’s mid-day prices.
Investors are broadly concerned that the post-pandemic boom and one-time fiscal stimulus will lead to a stalling of growth next year. This may be valid, but the market is giving the company little credit for the rejuvenation of its business, as the valuation multiple is essentially unchanged – the share price increase is only matching the earnings increase. If Signet can prove its staying power as a profitable jewelry company with even modest revenue growth, and show that its digital operations can fend off competition, the shares’ valuation should expand from the dismal 4.7x multiple of this year’s EBITDA to a still-modest 6x. We see additional upside to the shares.
Ratings Changes
Signet Jewelers (SIG): Raising price target from 65 to 80: The company’s blow-out first quarter results and guidance (see detailed discussion above) indicate considerably more value than we anticipated. Signet’s turnaround is going well, yet the shares remain at a discounted valuation.
This past Monday, we made several changes to our ratings and price targets:
Raised our price target on MolsonCoors (TAP) from 59 to 69: The company continues to make progress with its new product development and its efficiency initiatives, and is likely to see additional volume growth as its geographic markets fully open following the pandemic. TAP shares still do not adequately reflect the company’s value and earning potential. We are raising our price target from 59 to 69.
Raised our price target on General Motors (GM) from 62 to 69: General Motors’ fundamentals remain robust, even as its core earning power (gas-powered trucks and cars) is suppressed due to the chip shortage. EV competition from start-ups is fading, although Ford is showing a renewed vigor. Given GM’s impressive management, earning power and its positioning to be a winner in the eventual EV future (we see the industry transition as gradual, and occurring slower, than the consensus which implies an aggressive adoption rate for EVs), and its undervaluation on reasonably conservative metrics, we are raising our price target to 69.
Moved Biogen (BIIB) from BUY to SELL: With news of the FDA’s approval of its aducanumab treatment for Alzheimer’s, BIIB shares surged to over 400 (at one point reaching 468). We believe the treatment has immense potential, yet the share price embeds a tremendous amount of this potential. The Biogen investment produced a total return of 64%.
Moved BorgWarner (BWA) from BUY to SELL: BorgWarner shares have essentially reached our 57 price target, closing the sharp valuation discount that was present when we recommended the shares in August 2016. We see the risk/return trade-off as unfavorable and are moving the shares to SELL.
Fundamentally, the company is executing reasonably well and is making progress with its strategic initiatives, including transitioning to a world that eventually will be dominated by electric vehicles (we see the industry transition as gradual, and occurring slower, than the consensus which implies an aggressive adoption rate for EVs).
However, the company will likely continue to drive its transition by acquiring new-tech and e-tech companies, and these acquisitions will likely absorb much of BorgWarner’s free cash flow and borrowing capacity. This requires investors to put a high value on the company’s 5-year-out strategic and financial position. As the company is not likely to be price-sensitive or return-sensitive in pricing its acquisitions given the strategic (survival) imperative of its transition, we have little confidence that the 5-year-out value will be worth the wait.
The BWA investment produced a total return of 70%.
Moved Mosaic (MOS) from BUY to SELL: With the shares trading at or slightly above our 35 price target, we are moving MOS shares from BUY to SELL.
Conditions are exceptionally healthy in Mosaic’s markets: supply is tight, demand is strong and customers (farmers) are flush with cash from high corn, soybeans and other agricultural prices. However, we are starting to see producers nudge up their output, and we see the ideal conditions as a strong incentive for further production increases as well as eventual capacity additions across the global industry. The cycle could extend for another year, but the risk/return is not favorable enough to warrant a higher target price for MOS shares.
Despite the sharp 250% price gain since the March 2020 lows, and the shares now reaching nearly 6-year highs, the investment was essentially break-even, after dividends, from the September 2015 initial recommendation at 40.55. In hindsight, our outlook at our purchase was too optimistic, particularly with the onset of major fertilizer production in China. For contrarian investors, the profit comes from smart buying – if you buy a stock right, the profit is practically already made. But, we paid too much for MOS shares and so the profit was nil. Not every investment works as initially expected, of course – we’d rather recognize the error and take a break-even outcome now than hope for a better outcome when the odds don’t favor it.
Friday, June 11, 2021 Subscribers-Only Podcast
Covering recent news and analysis for our portfolio companies and other topics relevant to value investors.
Today’s podcast is about 14 minutes and covers:
- Brief updates on:
- Signet Jewelers (SIG) – blow-out earnings and full-year guidance
- Comments on our ratings and price target changes
- General Motors (GM) – expanding OnStar to anyone in the U.S. and Canada
- Toshiba (TOSYY) – independent probe finds company and Japanese government manipulated the shareholder vote
- Ironwood Pharmaceuticals (IRWD) – interim CEO becomes permanent. CFO to leave.
- Elsewhere in the Market:
- “Green” coal mining?
- Oil majors and production cuts
- State of Ohio’s shot across Google’s bow
- Selling shares at 5x their value.
Please feel free to share your ideas and suggestions for the podcast with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time limit we may not be able to cover every topic each week, but we will work to cover as much as possible or respond by email.
Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated recommendation. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” section but not before the fourth day after the recommendation has been emailed to subscribers. However, the chief analyst may purchase or sell securities mentioned in other parts of the Cabot Turnaround Letter at any time.