Signet Jewelers: Tough Spot, But Starting To Shine (NYSE:SIG)

In January of this year, I noted that Signet Jewelers Limited (NYSE:SIG) has come to life following the pandemic, a huge event which coincided with the transformation of the business. The company was on fire from an operating point of view, held a strong balance sheet, yet made a surprising deal.

Performing a balancing act, I was trying to learn more about the new margin potential, before making up my mind.

The Former Take

Signet Jeweler is one of the larger players in a huge, nearly $100 billion jewelry and watch market, mostly comprised out of independent franchises. In fact, the company holds just about a 6% share in this market, as its conglomerate basically consists out of a collection of brands, including Ernest Jones, H.Samuel, James Allen, Jared, Kay and Zales, among quite a few other names.

The company aims to squeeze out the best operational performance from these brands, including more e-commerce and omnichannel operations, while selectively pursuing M&A as well.

Signet posted its fiscal 2020 results basically at a time when the pandemic started, with sales that year coming in flattish at $6.1 billion. Operating profits (adjusted) came in at $318 million, for margins just north of 5%. This translated into adjusted earnings of nearly $4 per share, yet GAAP earnings only amounted to $1.40 per share, with large charges taken in relation to the restructuring of the business. Nonetheless, shares traded at non-demanding multiples at $25 per share.

Sales fell to just $5.2 billion in the fiscal year 2021, for obvious reasons, as adjusted operating margins fell to 3%, with adjusted earnings still coming in around $2 per share. Following this difficulty, the company has seen a very strong fiscal 2021 with real momentum showing up throughout the year as this confidence inspired the company into acquiring Diamonds Direct in October in a $490 million deal. This deal for the off-mall retailer looked a bit odd, yet could easily be financed, even as it was equivalent to roughly 10% of the own valuation.

By now, Signet guided for 2022 sales at $7.1 billion and operating margins near 10%, resulting in a boom in earnings. This triggered a huge rally to a high of $110 in November, and shares traded at $90 in January, even as the company kept hiking the 2022 guidance. Even more so, the balance sheet revealed a net cash position of a billion (even after the Diamonds deal), and with 63 million shares outstanding, that was equivalent to more than $15 per share. This implies that operating assets traded hands at $75 per share, at a time when earnings power trended around $10 per share.

This discussion above shows that the superior performance could not be maintained, as the question is what normal sales and margins levels look like, as the boom in the results coincided with the post-pandemic rally. I furthermore had not forgotten that this was a >$100 stock in 2015 following a big deal for Zale at the time, although this story was different as the company now operates with a strong net cash position. Not believing the current earnings to be sustainable, I concluded to remain on the sidelines, looking forward to the story unfolding.

Caution Saves The Day

Since urging this cautious tone at $90 at the start of the year, shares have seen a meaningful pullback as signs of a slowdown were obvious, although shares since have bounced from their lows around $50, to now trade at $65 per share again.

In March, Signet posted its 2022 results with revenues up 50% to $7.8 billion as operating profits topped $900 million, for margins of 11% and change. Earnings topped $12 per share, albeit that the momentum was much softer in the fourth quarter. For the fiscal year 2023, Signet guided for sales at around $8.1 billion and earnings at roughly $12.50 per share, basically indicating flattish results, but given the height of these results, it was very strong. Net cash stood at $1.27 billion, and that is after the acquisition of Diamonds Direct already, equal to $20 per share if we look at the diluted share count.

First quarter 2023 results, as released in June, revealed $1.8 billion in sales, up 9% on the year with organic growth coming in around 2%. While adjusted earnings were up, GAAP earnings took a huge beating amidst a $190 million litigation charge, among others. Net cash fell below $800 million, the result of continued share buybacks. Despite some softer results and uncertain outlook, the company did not adjust the full year guidance.

In August, a somewhat long-expected profit warning came as the company now sees full year sales at $7.65 billion, nearly half a billion cut on that front. Adjusted operating profits are seen just north of $800 million, a roughly $150 million reduction from the year before. This still translates into potential earnings of around $10 per share, still far from a shabby number.

With a diluted share count of 50 million, net cash is down to $16 per share. This is still a very modest valuation at $65 today, as operating assets are valued at just around $50 per share, and with earnings still trending at $10 per share, the resulting multiple only comes in at 5 times earnings.

With the enterprise value down to $2.5 billion, Signet actually announced a substantial deal as well. Despite the profit warning, the company has reached a deal to acquire Blue Nile in a $360 million deal. This deal looks a bit more expensive, set to add just half a billion in revenues, implying a 0.7 times sales multiple has been paid. In comparison, the company is now valued at just around 0.3 times sales.

What Now?

Momentum is clearly a bit soft. The company specifically mentioned that July was weak amidst the impact of inflation, and I clearly see more downside risks to the full year guidance. Even in that case, the balance sheet remains very strong. This remains the case as the Blue Nile deal can even be accompanied by aggressive buybacks, as the company can still maintain a net cash position after all of this.

This sounds pretty upbeat, and while from an earnings point there is definitely potential for lower sales and earnings, I guess the new normal should give some support to the valuation. A near $8 billion revenue base and 11% margins, as reported in 2022, are not substantial.

Perhaps a $6 billion and 5% margin number is perfectly fine as an average throughout the cycle. In that case, Signet is perfectly able to post average earnings of $5 per share, and for that, we need to see pretty big further downfalls in the results, and even in that case, the valuation looks pretty compelling. Amidst all this, I see appeal emerging, looking happy to initiate a small position here.