This jeweler handily beat earnings forecasts, crushing analysts’ estimates by $0.29.
Signet Jewelers (SIG)
From Cabot Stock of the Week
Signet Jewelers (SIG) is the world’s largest retailer of diamond jewelry, with retail stores in the U.S., U.K. and Canada. As of January 2017, the company had 3,682 stores located in malls and off-malls principally as Kay Jewelers, Jared, Zales Jewelry, Piercing Pagoda, H. Samuel and Ernest Jones.
Signet Jewelers is focused on the middle market with product price points from $50 to $10,000. This market accounts for around half of the $41 billion U.S. market. Signet acquired Zales Corporation for $1.4 billion in 2014, which increased the company’s market share from 9.7% in 2013 to 15.2% in 2017.
Diamond specialty retailers like Signet have experienced increasing competition from supercenters like Walmart and online stores. However, according to a survey by WeddingWire in 2013, around 47.7% of engagement rings were purchased from jewelry chain stores and only 6.5% from online retailers, indicating that diamond retailing is one of those retail business which is not significantly threatened by e-commerce websites like Amazon. Customer experience and expert advice in specialty retail stores is a major factor in consumers’ preference for brick and mortar specialty retailers.
The retail jewelry industry is highly fragmented, with the top three players accounting for only 21% of market share. Currently, Signet, Tiffany and Berkshire Hathaway’s subsidiaries, Ben Bridge Jeweler, Borsheims Fine Jewelry and Helzberg Diamonds, are the leading competitors in the space. As consolidation in the industry increases, competition will increase among the large players. And as disposable income continues to rise with the growing economy, diamond retail sales will see reasonable growth in the future. The sheer size of the company helps Signet to increase its bargaining power with suppliers, establish direct diamond contracts with mining companies and maintain strong visibility through its nationwide retail chains and TV advertisements.
Credit quality of receivables is a risk not to be ignored. However, due to the lower credit exposure of Zales, credit sales as a percentage of total sales is only 37% for the whole company, whereas for the Sterling division (which includes Kay and Jared Jewelers), it’s 62%. The company is planning to outsource its capital-intensive in-house credit program for a premium to private-label credit card provider ADS, which will help Signet retain more cash.
I consider this a better risk management strategy in the long run—at the cost of interest income. Since the acquisition of Zale Jewelry in 2014, the company has been working to increase the synergies between its Sterling and Zale divisions. Around 25% of Signet’s revenue comes from Zales. However, the operating profit margin of Zales is only 4% relative to 18% at Sterling Jewelers. Due to the fundamentally similar business models of both Sterling and Zales, I expect Signet to efficiently boost the operating profit margin of Zales with the help of better synergies and supply chain management. If Signet manages to boost the profitability of Zales to 10%, we can expect to see 12% growth in Signet’s operating profit, leading to a higher free cash flow in the future. I believe management’s recent strategic initiatives to outsource the in-house credit business and close Zales’ underperforming in-mall stores will yield better margins in the coming years.
Signet’s current revenue of $6.26 billion and net-profit of $325 million is expected to grow conservatively at around 5% annually over the long term. Signet plans to distribute 70% to 80% of free cash flows in the form of dividends and buybacks. With a current valuation of nine times earnings and an expected free cash flow yield of 10%, the company is a bargain for long-term investment. BUY.
Timothy Lutts, Cabot Stock of the Week, www.cabotwealth.com 978-745-5532, November 14, 2017