2023-10-31 08:06:23 ET
Summary
- Value stocks are important in a high interest rate environment as they tend to perform well and provide cash returns in the near term.
- Signet Jewelers is market leading in a highly competitive and cyclical industry.
- SIG has recently completed a significant transformation and has delivered strong results.
- SIG is trading at a very cheap valuation and represents an attractive investment opportunity at current levels.
Value stocks represent a key part of any high quality diversified portfolio. This is particularly true in a high interest rate environment, such as we find ourself in now. Value stocks tend to outperform in high interest rate environments due to the fact that they often return significant cash in the near term compared to growth companies which will return cash later in time.
Finding stocks that trade at low valuations is relatively easy given that there are many companies with weak prospects trading at dirt cheap valuations. However, many of those companies are value traps due to significant near term challenges.
By most conventional metrics Signet Jewelers ( SIG ), is a very cheap stock. While the stock trades at a below market valuation for a reason, I believe the stock is too cheap to ignore and represents a buy at current levels.
Company Overview
SIG is a the world's largest retailer of diamond jewelry. The company operates ~2,800 locations in North American and the United Kingdom under a number of brands including Kay Jewelers, Zales, Jared, Diamonds Direct, Blue Nile, JamesAllen.com, Rocksbox, Peoples Jewellers, H.Samuel, and Ernest Jones.
SIG has annual revenue of ~$7 billion which is 3x the size of its nearest competitor.
Over the past 5 years SIG has undergone a significant transformation. SIG has reduced its mall revenue penetration and instead focused more on the online marketplace resulting in >20% eCommerce penetration. SIG also has exited the financing business and currently has zero consumer credit on its balance sheet. Previously, SIG had carried an on balance sheet consumer credit portfolio.
Highly Competitive Industry Resulting in a Thin Moat
SIG is the largest player in a highly competitive industry. SIG competes with department stores such as Macy's ( M ), Neiman Marcus, Nordstrom ( JWN ), Saks, and others. SIG also competes with many smaller independent jewelers as well as major retail companies such as Costco ( COST ).
That said, SIG has ~9.7% market share which is three times larger than its nearest competitor. SIG shares has increased from 6.6% in 2020. SIG's scale does give it some limited advantages in terms of sourcing opportunities and negotiating power with suppliers.
Historically, as shown by the chart below, SIG has only been able to achieve mid-single-digit profit margins and has experienced significant periods of negative earnings.
Highly Cyclical Industry
Given the relative high cost of jewelry, demand tends to be heavily dependent on economic conditions. This. SIG tends to experience very high earnings volatility and a highly volatile stock.
As shown by the chart below, SIG has exhibited an average historical beta of 1.43x which also confirms the volatile and high cyclical nature of SIG's business.
Historical Performance
On an inception to date basis, SIG has achieved a very strong return which has matched the S&P 500. However, SIG's relative performance peaked around 2016. As shown by the chart below, SIG has significantly outperformed the S&P 500 at that time.
However, SIG has not performed well on a relative basis in most recently history. Over the past 10 years, SIG has delivered a total return of just 8.2% compared to a 180% return delivered by the S&P 500.
Growth Projections
SIG believes it can generate $14 - $16 in Non-GAAP EPS over the next 3-5 years. This represents 42% to 63% growth vs FY 2024.
SIG believes that growth will be driven by a combination of factors including organic revenue growth, market share gains, and operating margin improvement. A recovery in the number of engagements back to pre-pandemic levels is expected to be an important growth driver.
Wall Street analysts appear skeptical of this guidance and the current consensus fiscal year 2025 (which end in January 2025) EPS estimate is $10.32 per share while the consensus January 2026 FY EPS estimate is $11.06
Strong Balance Sheet
SIG operates with a relatively strong balance sheet and leverage is near flat on a Net Debt to Adj. EBITDA basis. Moreover, SIG has significant liquidity which will allow the company to ride out any significant economic weakness. Thus, I believe SIG's strong balance sheet represents an important positive.
Strong History of Returning Capital To Shareholders
As shown by the chart below, SIG has returned a significant amount of capital to shareholders and has reduced the share count by ~44% over the past 10 years.
Generally speaking, SIG has a solid dividend history as well but suspended the dividend during the COVID-19 period before resuming the dividend at a lower level in 2021.
Valuation
The most favorable part of the SIG investment story is the valuation part of the story.
SIG trades at just 6.9x FY 2024 earnings and 6.5x FY 2025 earnings. Simply put, this is a dirt cheap valuation compared to the S&P 500 forward P/E ratio of 17x. Additionally, SIG is even cheaper based on the company's forward EPS guidance of $14- $16 over the next 3-5 years.
While SIG does not have a many true public comps, we can look at other highly cyclical companies to get a sense of relative valuation. SIG is currently trading at valuation levels comparable to airline, steel, and automobile companies which typically trade at very low valuations due to their cyclicality. For example, General Motors ( GM ) is trading at 4x 2024 earnings while Ford ( F ) trades at 5.5x 2024 earnings. On the airline side, American Airlines ( AAL ) trades at 4.7x 2024 earnings while Delta ( DAL ) trades at 4.6x 2024 earnings.
On an EV / EBITDA basis SIG is trading right in line with AAL and DAL and at a substantial discount to GM and F.
While SIG is trading in line with other cyclical companies, I believe SIG is a much better business. SIG is the far and away market leader and enjoys some advantages due to its scale relative to competitors. SIG also operates a relatively asset light business and has a strong balance sheet. Moreover, on a long-term basis SIG has delivered shareholder strong results. Comparably, all major airlines with the exception of Southwest ( LUV ) have gone through bankruptcy.
SIG appears to be trading at a reasonable valuation vs its historical norm but the picture is mixed based on the metric. For example, SIG is trading at a moderate premium to historical average forward P/E ratio and forward EV / EBITDA but a discount to its historical norm on an EV / Revenue basis.
Risks to Consider
The biggest near-term risk I see for an investment in SIG is the potential for a sharp economic slowdown. If the economy were to fall into a deep recession SIG would have a hard time delivering strong earnings.
However, a period of economic weakness has the potential to benefit SIG over the long-term as other less well capitalized competitors may find it more difficult to survive. Moreover, economic weakness could create opportunities for SIG to acquire other smaller players and continue to grow market share.
Conclusion
SIG is the market leader in a highly competitive industry. SIG benefits from its scale and strong balance sheet which provide a modest competitive advantage relative to smaller players.
SIG management has recently implemented a significant overhaul of operations which has resulted in improved efficiency and increased market share. While the company believes it can achieve significant earnings growth over the next 3-5 years, Wall Street analysts remain skeptical.
SIG trades at a dirt cheap valuation of 6.9x forward earnings compared to 17x forward earnings for the S&P 500. Moreover, SIG is trading at a valuation which is similar to valuations exhibited by firms in much tougher industries such as autos and airlines. While SIG faces significant competition, I believe the company enjoys a more favorable business than airline, auto, or steel companies.
I am initiating SIG with a buy rating and would consider downgrading the company if the valuations becomes less attractive. Moreover, I would also consider downgrading SIG if a recession becomes more likely.
For further details see:
Signet Jewelers: Too Cheap To Ignore