Taking a first look at Signet Jewelers
Some investors – and plenty of speculators – scour the 52-week-high list, looking for stocks with "momentum" to try to ride higher...
Sometimes this works, of course – just ask the folks who've owned chipmaker Nvidia (NVDA) over the past few years.
But being the contrarian value investor that I am, I prefer to pick among the stocks that are at 52-week (or, even better, multiyear) lows – looking for the occasional baby thrown out with the bathwater.
I also like "second bites at the apple." By this, I'm talking about a stock I once owned or recommended, made a lot of money on, exited, and then came back to after it fell back to the price at which I initially liked it.
That's what has happened with jewelry retailer Signet Jewelers (SIG)...
Back at my former firm Empire Financial Research, I recommended the stock at a reference price of $62.51 per share in the June 2023 issue of my prior newsletter, Empire Investment Report.
When I saw that my good friend and famed investor Michael Burry of The Big Short fame had initiated a small position, I spoke at length with him to get up to speed on the thesis. As I've said many times, I don't shy away from stock ideas that I didn't discover myself – particularly if they come from world-class investors I know personally.
It was a great call, as Signet quickly soared to more than $100 per share by the end of that year. The stock was also above this level as recently as this past November.
But it has been all downhill since then... capped by a 22% crash yesterday to a multiyear low of $58 per share after the company preannounced disappointing results during the all-important holiday season.
Sales and adjusted operating income missed the prior forecasts by about 4% and 17%, respectively, as you can see in this table from the company's press release:
As you can see in this chart, the stock has been erratic over the past 20 years, but investors with good timing have made multibagger returns:
So is it time to take another bite of this apple? Let's take a look at the company today, starting as always with the historical financials...
Signet's revenues and earnings – like its stock price – have been erratic, with a crash in earnings from 2018 to 2020. The pandemic closures explain 2020, but what happened in 2018 and 2019?
(Note that the dates in these charts are calendar year, not the company's fiscal year – which ends in January).
The cash-flow statement is equally strange...
Signet has always generated positive free cash flow ("FCF"), even during 2008 and 2020, but why was there a huge surge in 2017?
The answer is that before 2017, Signet not only sold its customers jewelry but also financed it directly.
This was such a large portion of its business that many Wall Street analysts (and short sellers who were betting against the stock) argued it was more of a finance company than a retailer.
Extending customers so much credit was risky, which depressed the multiple that investors were willing to pay for the stock. It also weighed on Signet's balance sheet and cash-flow statement.
We can see what was happening by looking at Signet's accounts receivable...
Most retailers have little or no accounts receivable, as customers pay via cash, check, or credit card at the time of their purchase. For example, Walmart (WMT) and Costco Wholesale (COST) have "days sales outstanding" – how many days it takes them to receive cash for what they sell – of 4.5 and 3.5 days, respectively.
In contrast, Signet averaged approximately 100 days sales outstanding from 2008 through 2016. By the peak in 2016, the company had extended its customers more than $1.8 billion in credit. Take a look...
With so much capital tied up on its balance sheet, Signet's operating cash flow suffered... which is why there was such a disconnect between rising revenues and earnings on the income statement and flat/declining operating cash flow from 2009 to 2015.
The key thing to notice is that starting in 2017, the company bit the bullet and completely shut down extending credit to customers directly.
This caused accounts receivable to drop to almost zero and operating cash flow to surge. But it also crashed the stock – as you can see in the chart above – as investors realized the company had sold them on a growth story that was unsustainable, driven by extending more and more credit to riskier and riskier customers.
Turning to the balance sheet, Signet currently has about $1.2 billion of net debt, $852 million of which is long-term lease liabilities (accounting rules changed in 2019, requiring companies to show this as a form of debt, which is why Signet's net debt spiked that year):
In terms of capital allocation, Signet has made one big acquisition, Zale, in 2014... it foolishly tried to prop up its cratering stock from 2016 to 2018 with share repurchases at high prices... and it pays a small dividend.
Lastly, let's turn to valuation...
After the massive crash yesterday, the stock is down to a $2.5 billion market cap and, adding the net debt, a $3.7 billion enterprise value ("EV").
With trailing sales of $6.8 billion, its EV-to-revenue multiple is a mere 0.54 times.
Trailing earnings before interest, taxes, depreciation, and amortization ("EBITDA") is $639 million, so its EV-to-EBITDA multiple is 5.8 times.
But of course, what really matters is earnings – and with yesterday's warning that adjusted operating income during the holiday season was 17% below expectations (plus revenues have declined over the past two years, as you can see in the chart above), investors are rightly questioning the company's future prospects... and analysts will be sharply reducing their consensus earnings estimates for next year of $10.61 per share.
That said, with the stock nearly cut in half in only a month and a half, the sell-off could be overdone... so I'm intrigued enough to take a deeper dive. I'll do so in tomorrow's e-mail – stay tuned!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.