Description

Signet Thesis

Signet is the largest player in the mid-tier US jewelry and watch market. The company’s portfolio covers 80% of category spend and includes banners such as Kay Jewelers, Zales, Jared, Diamond Direct, and Blue Nile.

Thesis Points

Comp growth approaching normalization vs. pre-pandemic

• Jewelry spend spiked with the pandemic stimulus impact and Calendar ‘21 comp sales grew +48.5%. This has been followed by 6 quarters of negative comp growth as transactions reverted. 3Q/4Q comps for this year will be negative as well per most recent guidance. This guidance implies a ~2% comp CAGR vs. 2019 which reflects a reversion back to a normalized level and a base that the company can grow from.
• Average transaction value has held up (+40% vs. pre-pandemic). Per management the growth is primarily mix-driven (Diamonds Direct / Blue Nile acquisitions) and tiering up of products with less than 10% due to pricing increases. Promotional levels industry-wide have been elevated this year as independent retailers are working through excess inventory, but the company has still been able to show ATV growth the past couple of quarters.

Market share leader in fragmented industry / expect market share gains to continue

• ~17k small/independent jewelers make up ~60% of category sales
• SIG share has improved to ~10% versus ~6% pre-pandemic with mid-term goal of 12% share.  
• Pre-pandemic the trend was ~300-500 independent door closures per year. That trend has been running lower the past few years as business stimulus payments gave independents a longer runway and SIG has instead taken share from big box/dept store retailers. As the independent door closure trend reverts to normal (which is more likely in a tougher macro backdrop) SIG should again continue to pick up share from that market segment.    

Changes to business over past 4-5 years put company in structurally improved position

• Store footprint rationalization/omnichannel model:
  • ~1000 store closures / ~550 net store closures over the past 5 years as the company has closed unproductive doors and opened new doors in off-mall/better locations leading to improved square foot productivity.
  • Traditional mall locations formerly represented ~60% of the company’s locations and this has moved lower to ~40% (mostly A/B+ malls) with off-mall/online comprising the balance. This is still a sizable amount of mall exposure which presents ongoing risk, but is also reflected in valuation.  
  • E-commerce 27% of North America business and 17% of International business versus 12%/11% 5 years ago.
• Inventory turns/management has improved via narrowing of vendor base, SKU rationalization, and introducing flexible fulfillment capabilities from e-commerce orders. Clearance and promotional levels have come down versus historical levels as a result of these measures.  
• Improved labor productivity
• Product sourcing improvements 
• Expansion of services business which carries much higher margins
• These changes underpin management’s 11-12% operating margin target by Fiscal ’26-’28
  • While operating margins look elevated versus pre-pandemic level of 5%
• Credit business now fully outsourced

Engagement trends on path toward normalizing  

• Engagements have been running negative the past 2 years as a result of Covid impact and management expects this trend to begin to improve beginning in 4Q of this year. The expectation is that the trend remains negative but improves from mid-teens decline to -M-HSD declines, which would drive a sequential imrpovement in comp  
• Bridal represents ~50% of SIG revenues. Engagement comprises ~2/3 of sales within this business with wedding bands/other bridal related (wedding party gifts etc.) make up the remaining 1/3. Signet has over 30% market share in this ~$12.5bn market.  
• Bridal is historically less cyclical part of business. If engagements recover and bridal comp sales recover accordingly while the services comp continues to grow inline with current trends, this can offset negative sales in the more cyclical fashion jewelry part of the business should a weaker macro backdrop persist.

Plenty of consumer uncertainty remains but the company’s FY guidance does not seem overly aggressive.

• The high-end of management’s 2023 guidance contemplates a macro environment consistent with 2Q while the low-end contemplates some worsening in the macro backdrop and impact from student loan resumption on ~20% of its customer base. $150m of cost savings are expected to flow through (split evenly between cost of goods/SG&A) in 2H while  Blue Nile will be less of an expense drag. 

Strong balance sheet / cash flow 

•  $600 to $700 FCF generation potential per year equates to 17-19% FCF yield 
• Additionally, while not necessary for stock to work, redemption of the company’s convertible preferred shares would be accretive and adds interesting optionality. In October 2016 the company issued convertible preferred shares to Leonard Green for $625m. The convertible preferred shares become redeemable November 2024 and the company could strike a deal before then which would be accretive to the equity 

Valuation / Price Target

• Shares are trading at 4.6x EV/EBITDA and 7.5x P/E on consensus estimates for this year ($800m / $9.60) which is a discount to other mall-based retailers.
• Assuming a return to LSD comps and ~10.5-11% operating margins in 2 years + share repurchases, the company can earn EPS in the $12.50 to $13 range. At 9-10x P/E equates to $112 to $130 (57-81% upside)     

Catalyst

Earnings