After an incredible pandemic run, Signet Jewelers Ltd. (NYSE: SIG) the stock ran out of steam. The company is down nearly 29% from November’s intraday high of around $111/sh, and despite strong fourth-quarter results causing the stock to rise nicely, shares have started falling again:
The reason for Signet’s lackluster performance is largely unrelated to underlying fundamentals. The company has just had a record year in terms of sales and profitability, its balance sheet remains solid and Signet continues to increase its market share. Additionally, management’s guidance for FY23 is in line with expectations and Signet has recently increased additional resources for its capital allocation plan.
Instead, Signet stock price is under pressure from a rather challenging macroeconomic environment. There are overriding concerns that challenge Signet. First, inflation and the fear that it will squeeze discretionary spending; as well as the Fed’s increasingly hawkish inflationary policies that are likely pushing the US into recession. Second, consumer spending in 2022 is expected to shift more towards experiential activities and travel as the US and UK emerge from the pandemic. Third, global sanctions against Russia. Russia is one of the world’s largest diamond producers and sanctions that prohibit the export of the commodity out of the country could disrupt Signet’s operations in the future.
These two concerns not only held back Signet’s stock price, they put pressure on the consumer discretionary sector as a whole:
Unfortunately, until these concerns subside, Signet’s share price will remain under pressure. And because of these factors, it was decided to temporarily suspend a price target for the shares. That said, Signet remains well positioned to deliver on its promises to grow market share, maintain double-digit operating margins and return capital to shareholders. So, Bookmark is recommended as HOLD.
Signet’s results for fiscal year 2022 were exceptional. The company recorded sales of $7,826 million, up 49.7% from FY’21 and 27.5% from FY’20. The surprising acceleration in Signet sales led to a sharp increase in the company’s market share. According to the company’s FY’22 10-k, Signet increased its market share by 270 basis points, from 6.6% in FY’21 to 9.3% in FY’22. At its Investor Day last spring, Signet set a goal of capturing 10% of the market, a goal that now seems within reach.
Margin growth was even more impressive than sales growth. Operating margins increased from 5.2% in FY20 and 3.2% in FY21 to 11.6% in FY22, an increase of 620 and 840 basis points respectively. Margin improvement was driven primarily by strong business momentum, fixed cost operating leverage, inventory optimization and structural cost savings resulting from Signet’s previous transformation strategy.
Management expects margins to remain around FY22 levels with FY23 operating margin forecasts between 11.2% and 12.1%. This is entirely achievable given that many of the factors mentioned above are not transient. Additionally, Signet is well insulated, unlike other consumer discretionary retailers, from inflationary pressures on its supply chain and consumer prices:
Our financial health and strong supply chain relationships allow us to deliver great value to customers despite inflationary pressures, while protecting and growing margin. As a result, we believe we will be less impacted by inflation than our competitors in the jewelry industry or the retail sector as a whole. To dig a little deeper, our supply chain is an important source of competitive advantage. We are a sightholder with De Beers, which allows us to purchase rough diamonds directly. We have an exclusive online diamond marketplace through James Allen. This gives us real-time pricing on over 450,000 cut and polished stones valued at over $2 billion. We now have seven manufacturing plants, in India, outsourced to work exclusively for Signet, in addition to our own cutting and polishing manufacturing plant in Botswana. In total, we multiplied our production capacity tenfold last year. This level of large-scale vertical integration, along with our strategic supplier partnerships, gives us a huge advantage in terms of quality and inventory volume. FY’22 Q4 conference call.
Finally, FY’22 was an exceptional year in terms of profitability for Signet. The business generated $12.28 adj. EPS for the full year, compared to $2.11 in FY21 and $3.88 in FY20. Earnings, in turn, drove incredibly strong cash flow for Signet, generating $1,257 million operating cash flow and $1,128 million free cash flow. The company used its available cash to complete two acquisitions – Rocksbox and Diamonds Direct – at a cost of $516 million, repurchase approximately $312 million in common stock and pay $44 million in ordinary and preferred dividends. Even after the cost of acquisitions and returning cash to shareholders, Signet increased its annual cash position from $246 million to $1,418 million.
Increase shareholder value
Even though the market is unwilling to reward shareholders for Signet’s outstanding performance and improving fundamentals, management has decided to take over. Signet recently announced an 11% increase in its dividend, now to 80¢ per year, and has just completed a $250 million accelerated stock buyback agreement, leaving the company an additional $413 million authorized for redemptions. Signet purchased a total of 3.2 million shares in FY22, which equals 6% of the 52.3 million shares outstanding at the end of FY21.
Signet’s low valuation and abundant cash position provide management with the opportunity to continue to aggressively buy back shares without sacrificing the company’s fortress balance sheet. Shares of Signet are trading at a simple adjustment of 6.5x TTM. P/E and 6.2x FWD P/E, and the company has $1.4 billion in cash at the end of the year with only $147 million in debt not due until 2024. With a cushion of cash this large and such a low valuation, management could and should continue to buy back shares unceremoniously while stock market sentiment remains in disfavour.
In conclusion, Signet continues to lead the way as the premier jewelry retailer in the United States. The company’s share price is currently being punished for things largely beyond its control. Despite the lagging share price, Signet continues to gain market share, increase margins and accelerate the return of capital to shareholders. Therefore, while the short term remains contested, Signet is poised to win in the long term.