Signet Jewelers Ltd. Is the Real Gem in Jewelry, Even at $100 a Share

This specialty jeweler can still mine opportunity from its soon-to-close merger.

Apr 10, 2014 at 9:13AM

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The expiration of the Hart-Scott-Rodino antitrust waiting period means Signet Jewelers (NYSE:SIG) is almost done polishing off its $1.4 billion acquisition of rival Zale (UNKNOWN:ZLC.DL). Even though its stock sits 28% higher than when it announced the deal -- and is 50% above where it traded one year ago -- Signet remains undervalued, so investors shouldn't think they've missed a chance to mine this diamond in the rough.

Even without the purchase, Signet is the industry's largest specialty jeweler. It commands a roughly 10% share of the U.S. market through ownership of brands including Kay Jewelers and Jared, the Galleria of Jewelry. Adding Zale will give Signet a 15% market share, making it three times the size of its nearest rival.

That gives it a significant sweep of what is largely a fragmented industry populated mostly by small, independent jewelers. Signet also has the potential to drive greater savings to vastly expand its bottom line, and this is where investors should view its $100 price per share as an opportunity.

The specialty jeweler says it anticipates realizing about $100 million in operating synergies from the acquisition. Companies often make such claims, which just as often fail to become reality. One analysis suggests that 50% to 75% of all mergers fail to generate any value for the buyer, but I think Signet can be different.

First, the union will give Signet global scale with market-leading shares in the U.S., Canada, and the U.K. Primarily through its Peoples Jewellers brand, Zale has the largest market share of any specialty jeweler in Canada, and same-store sales were up 5.7% last year and 2.7% last quarter on a constant currency basis. Comps at its namesake Zales store were up 4.9% and 3.9%, respectively, over those time periods. Signet owns the leading position in the U.K., where it operates nearly 500 stores under the Ernest Jones and H. Samuel brands. When the merger is complete, the new Signet will hold a commanding lead over its rivals here at home.

Second, Zale is in the midst of a turnaround that has for the most part been successful, allowing the jeweler in 2013 to post its first profit in five years. It holds a couple of chains that are still struggling, namely Gordon's and Mappins, but that's where Signet's expertise in sourcing, marketing, and consumer credit can pay off. In particular, the strength of Signet's financing program will allow it to fund part of the acquisition's cost with its accounts receivable portfolio.

Third, Signet has the potential to build on its position as the biggest mid-tier jeweler. While Jared positions itself at the higher end of the spectrum, targeting customers with annual incomes of $50,000 to $150,000, its sales account for only 25% of Signet's revenue. Kay, on the other hand, is its mid-tier jeweler, serving household incomes between $35,000 and $100,000, and representing more than half of total sales. 

Zale has called itself the jeweler of Middle America, but it sells more diamonds than any other jeweler in the U.S., and its bridal collections represent the largest part of its business. Although it could use that focus on diamonds to go upscale, it tried that route once before and failed miserably. Staying in the middle market should suit it just fine. Its turnaround may have caused it to experience lower average ticket sales, but it's also led to increased profit margins.

This is a truly strategic alliance that hasn't finished playing out yet. Admittedly, the sketchy economy could play havoc with how quickly the two can integrate and the benefits that flow through to the bottom line. However, investors with a long-term outlook will find that a global player that can build on opening new international opportunities while still driving business at home will be a jewel in their portfolio.

Still worried about Signet's value? Check out this diamond in the rough!
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