“Celebrate Returns, Express Love” Signet Jewlers

12

Business Description

Company: Signet Jewelers is the largest specialty jewelry retailer in the United States, the United Kingdom, and Canada. The company is incorporated in Bermuda and accordingly is headquartered in Hamilton, Bermuda. Signet operates 3,606 stores spanning all 50 of the United States, the United Kingdom, Canada, the Republic of Ireland, and the Channel Islands. (Exhibit 1)Strategically differentiated brands paired with exclusive merchandise and outstanding customer service creates a compelling value proposition for customers of all demographics. Signet’s goal is to create and offer jewelry and watch products that bring joy to its customers as they celebrate life and express love. This is ensured by utilizing an extensive supply chain as well as maintaining impressive and diverse merchandise. Signet’s operating principles are as follows: excellence in execution, testing before investing, continuous improvement, and disciplined investment in all aspects of business.

4

Recent Stock Performance

While Signet stock has had its ups and downs its overall performance has been a steady increase. (Exhibit 2) In 2014, many of Signet’s ups and downs have been triggered by news of the acquisition but all in all indications are that of a successful decision.

A: October was a bad month all around. The S&P reached record lows reporting on October 15th trading at 7.4% below the peak of 2,011.36 it reached in September; and 9.6$% below at the end  of October. Signet also dropped around 10% below what it was trading at in September after reporting fewer earnings than expected. We saw it go down to $101.00.

B: On November 25th     Signet reported an 18.64% earnings surprise; the stock skyrocketed to

$131.59; while the S&P remained stagnant.

C: In December Signet and the S&P went down since Black Friday sales decreased 16% from

$59.1 billion to $55 billion this year; also, the retail outlook for the holiday season was uncertain. Also, Signet decided not to run any deals or promotions in order to save their bottom line.

D: Signet shot up in the beginning of January when they reported their holiday sales were better than expected; same store sales increased by 4% overall with the Sterling Division seeing  increases of 9%. Around January 15th we see them drop because Tiffany’s reported lowered earnings forecast for Q1 2015. Signet announced they will stand by their guidance.

5

Recent News

Most notably in recent news, Signet acquired its closest and largest competitor Zale’s, which is contributing greatly to top line and bottom line sales and growth. Zale’s contributed to over 70% e-commerce growths for Signet in Q4 2014 leading to a 90.9% increase overall in sales last quarter. Around 1500 store managers underwent extensive training to gain an understanding of the Signet Organization. This is the first time such an extensive training took place, which really speaks to the company’s dedication to upholding quality in brand value. Diamond buying sky rocketed in December. Diamond sales increase about 20% in December. Signet jeweler’s same store sales increased about 4% overall this past holiday season. Although diamond prices are down this year, about 8% for 1 carat, higher end jewelry is a rapidly growing market. Sales of diamonds that are 3 carats or above are increasing. We are starting to see another trend in diamond buying; while December sales skyrocket because of the holidays (Christmas, Hanukah, etc.), February  sales also increase because of the Chinese New Year. Signet is performing above its peers as Movado stock dropped 11.3% on January 16, and Tiffany’s slumps 14% in holiday sales and weakens its guidance.

Products: Historically, Signet’s revenue breakdown has remained very stable. Over the last five fiscal years diamonds and diamond jewelry have accounted for 59.24% of sales. Recently diamond revenue  allocation  has  increased  7%.  Gold,  silver  jewelry,  other  products  and  services have

accounted for 29.46. (Exhibit 4) Signet far outperforms the 5 year industry revenue growth projection of -10% with estimated revenue growth of 19.34%. Signet offers the following products (% of all revenue):

Diamonds and Diamond Jewelry (60.6%): Diamonds account for the majority of Signet’s sales. These are also their biggest source of revenue. As demand for larger sized diamonds increases, so will Signet’s attractiveness in the market. Signet owns a rough diamond sourcing and manufacturing subsidiary, which ensures Signet an allocation of the rough diamonds extracted by Rio Tinto as well as several other

Gold, Silver Jewelry, Other Products and Services (29.4%): Nearly 30% of sales are accounted for between two categories: gold, silver, other precious metals and semiprecious metals for jewelry and then services. The second half of this sales component is through custom design and services. This is an important part of the business because it offers the opportunity to build brand loyalty and consumer confidence in the company. Signet recently started an initiative to host private events at its various

Watches (10%): Watches account for 10% of Signet’s sales. Even though diamond sales are increasing it’s not at the expense of While watches make up a small percentage of Signet’s segmentation, luxury brands and demand justify its significance.

Growth Strategies: Signet has five main growth strategies: Capitalize on Mid-Market dominance, strengthen their Best in Bridal initiative, technologically advance their stores, expand, and train their people. Since Signet acquired Zale’s they eliminated their only meaningful competitor. This allowed them to capture more than half of the jewelry industry with a 55.45% market share. (Exhibit 5) They now have maximum control of the mid-market and are capitalizing on this by offering popular jewelry and eliminating slow turning inventory. By acquiring diamond factories in Botswana and India as well as entering in an agreement with DeBeers to have great access to the supply of  diamonds, will be helpful as they offer the most extensive diamond collection for engagement rings, wedding bands and overall jewelry. By integrating technology into their stores they can educate their customers more thoroughly about diamond buying. By updating their stores they are also pushing the promotion of private events at their stores further increasing their bottom line. Most importantly, Signet is investing in their human capital. These strategies are expected to strengthen the signet brand through external and organic growth.

6

Earnings Call

The third quarter of fiscal year 2015 was solid. Signet’s comps increased by 4.2%. Signet merchandise including fashion diamonds, watches, and branded bridal collection all performed well. Profits in this quarter were diluted by the seasonally low sales volumes and increased fixed costs  since the acquisition of Zale’s. Despite this fact Signet’s success was driven by their 3 main competitive strengths: customer experience, creative marketing, and exciting merchandise. Signet is also successful in watches; their luxury brands saw increased results and a strong performance this quarter. Signet’s sales growth was driven by ecommerce sales of $44.8 million, which is an increase of 97% due to the acquisition of Zale’s.

Signet also strengthened their fourth quarter marketing approach. Instead of increasing marketing expenses signet kept marketing the same. Increasing the mix of Vera Wang Unstoppable Love and Sofia by Sofia Vergara, while simultaneously cutting 10% of slow turning revenue, Signet plans to save over $175 million by fiscal year 2018. With a new store design in many Kay stores; Signet has been testing technology integration within stores set to launch in December 2014. Signet entered into an agreement with DeBeers in order to have a greater supply to the unpolished diamonds. In the third quarter the Sterling Division, total sales increased 9.7% to $692.8 million driven by fashion jewelry and branded bridal. UK division total sales were up 8.4% to $151 million driven by watches  and  diamonds.  Net  inventories  increased  by $1  billion  or  62.6%  driven  entirely by the

acquisition of Zale’s. Since the acquisition Signet has strengthened its balance sheet with $1.4 billion of long term debt at 2.6%. Signet is set up for a strong Holiday season beginning December 2014. For the first time in 20 years signet brought together over 1500 store managers for vision 2020 training to gain an understanding of how they fit into the signet brand. This was done to help managers regain focus for a strong performance in the holiday season.

December 2014 Sales and Revenue Call: Most important to note this holiday season was signet’s decision to eliminate 0% financing of its large purchase diamonds and jewelry; as well scaling back on any promotion or deals. They were also able to save marketing costs by relying on the establishment of their brand and the inclination of American men to buy their wives jewelry. Unless these American men are going to a low cost retailer such as Wal-Mart or a high end store such as Tiffany’s, they will go to a Signet store. This allowed them to hedge against the effect to their top and bottom lines from the acquisition of Zale’s. The 2014 Holiday season led to a 45.3% revenue growth for signet Jewelers. The diversity and global reach of Signet’s jewelry portfolio helped deliver a good holiday performance. Signet’s Ecommerce sales went up by 91% in December alone. Total Sales for the holiday season were $1.9 billion, an increase of 45.3%. What drove sales was Signet’s exclusive focus on the Vera Wang collection; including new advertisements and revamping of their Celebration Diamond and Arctic Brilliance Diamond. Private events for preferred customers also contributed to sales increases in December. Signet has reaffirmed its guidance for January 2105 based on holiday sales and expectations of continued growth into January and February.

Earnings: Signet has consistently beat earnings since 2011 Q1 except for 2014 Q3 when they acquired Zale’s corp. On August 25th, 2011 signet beat Earnings by 29% when the estimate was $0.58 and actual was $0.76. (Exhibit 6) On November 25, 2011 they beat earnings by 18.64%. Tiffany’s lowered their outlook by 1% from $4.20-$4.30 to $4.15-$4.20. In the same week Movado stock fell more than 11%. Despite these hits to competitors they are sticking by guidance and $3.03 forecast.

78

Pro Forma Income Statement

As seen in my pro forma income statement below I gave Signet higher expected earnings than the analysts, since I am forecasting higher expected sales from the holidays during that time Period. First there’s Valentine’s Day and now we are seeing higher store traffic for the Chinese New Year. I am giving Signet more conservative earnings for Q2 and Q3. I did this because Signet moves with its competitors and despite their own triumph they go down with the Tiffany’s and Movado’s. I calculated higher earnings for Q4 expecting sales to grow exorbitantly as well. By next December Signet and Zale’s will have achieved synergy and will expect higher foot traffic than usual. Inventory will be turning faster than before and product offering will be better tailored towards customers.

 

 

 

 

 

Investment Risk

Economic Conditions: Jewelry is a luxury expense. Unless people have the extra income to fund their purchase they cannot sustain a jewelry buying habit. Jewelry consumption is highly sensitive to consumer  spending.  Purchases  are  discretionary  and  are  dependent  upon  consumer  confidence,

unemployment, GDP, interest rates, taxation, credit, and many other economic variables. Furthermore, the level of consumers’ disposable income and income available for discretionary expenditure is directly tied to the continued success and growth of Signet Jewelers. While the UK is not a member of the Eurozone, economic conditions can have a significant impact on sales. 16% of Signet’s sales are accounted for by the UK division.

Fluctuations in Foreign Exchange and Commodities Risk: Approximately 88% of Signet’s total assets are in entities whose operational currency is the US dollar. 84% of sales and 93% of operating income are denominated in the US dollar. Nearly all remaining assets are in pounds sterling. This  mix of currency denominations causes results to be subject to any fluctuations in the exchange rate between the pound sterling and the US dollar. Any volatility in the weighted average value of the pound sterling affects reported sales and operating income.

Availability of Diamonds: Diamonds account for about 47% of Signet’s merchandise costs with gold accounting for 15%. The cost of diamonds is anticipated to rise over time, although fluctuations in price are likely to continue to occur. Although gold makes up a small percentage of Signet’s product breakdown it sees extreme volatility and directly affects Signet.

9

Valuation

Growth Duration Model: The growth duration model is based on the price to earnings ratio of the current ratio of two companies or industries. For this model I compared Signet to the specialty store industry. This is a relevant comparison since signet has such a large market share in its own jewelry market having dominance over the whole mid-market jewelry. Signet’s closest competitor since the acquisition of Zale’s is Tiffany’s. While Tiffany’s is a high end jewelry retailer it competes with all  of Signet’s retailers. For this model I used earnings growth rates (Exhibit 7) of: pessimistic growth of 13.49%, anticipated growth of 19.34% and optimistic growth of 25.19%. After my calculations I reached a fair value price of $141.86, indicating that Signet is undervalued by 14.5%.

Franchise Value Model: The franchise value model is used to evaluate the return associated with a future expansion of the firm. This model is perfect for evaluating Signet since it’s entering a new era of growth and expansion. With a return on equity of 14.09%, an ROE growth rate of 19.34%, a required rate of return of 10.2%, and BPS of $32.95, and BPS growth of 8% this model yielded a fair price of $152.88 which indicated that it is undervalued by 23.4%.

Average Fair Value: My valuation models calculated an average fair price of $147.37 for Signet, indicating that it is undervalued by 18.95%. Since we have almost reached that target with a cost basis of $119 per share we want to lock in that 22% return within the remainder of our workout period. With a recent acquisition that boosted sales by 90%, and entrance in a new era of growth and transformation reaching this target is feasible.

Analyst Recommendations: According to Bloomberg, there are 15 stock analysts tracking Signet stock. 72.2% of the analysts recommend a strong buy on Signet, 22.2% represent a hold, and only 5.6% represent a sell. The average target price is 145.64, its highest was $150 and its lowest was

$129.16. Its last close was 123.02 making this an attainable target.

Recommendation

Attractive Valuation Indicates a Hold: Signet’s just began its new growth initiatives, which gives us the opportunity to profit off their continued success. With over 50% of the market share and virtually no competitor Signet should be held. I performed the Growth duration and Franchise Value model to find Signet undervalued by 14.5%. My fair value is $147.57, which suggests we should  hold Signet.

 

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