One Jeweler Might Be a Buy Now

The jewelry industry just got a little smaller; here's the best way to invest.

Jun 24, 2014 at 9:52AM

Signet Jewelers (NYSE:SIG) recently completed its acquisition of Zale (UNKNOWN:ZLC.DL) after a majority of shareholders approved the transaction. With the completion of the transaction, Signet is an even larger player in the specialty jeweler market. It now owns upward of 15% of the U.S. retail-jewelry market share, which is three times that of its nearest rival Tiffany (NYSE:TIF). However, these numbers indicate the fragmented nature of the market and the number of independent dealers who operate in it. Still, Signet is an even greater force to be reckoned with than ever before.

Implications of the acquisition
Now that Signet owns some of the best-known names in the industry, including Kay Jewelers, Jared, the Galleria of Jewelry, and now Zale, it has the opportunity to expand and consolidate its presence. It will have more than 3,600 locations generating $6.2 billion in revenue and is expected to save more than $100 million in costs across purchasing and sourcing, repair services, and overhead.

Zale's largest owner, activist investor TIG Advisors (which owns 23% of the company), was against the deal. The firm thought that the deal undervalued Zael. Assuming that TIG is correct, then Signet got a good deal by only paying around $700 million for Zale.

Synergies of the acquisition
Normally, an acquiring company sees a decline in its share price after the announcement, but in this case, a clear sign that the market welcomes the transaction can be seen in the 30% rise in the price of Signet.

Signet could possibly gain from the acquisition even earlier than expected, with the additional lead over Tiffany helping. Signet is already the leader by market share in the US and the UK and will now have a significant presence in Canada, where Zale is the market leader.

The nature of the jewelry market
The jewelry market is insulated from the downturns of the underlying economy, and despite the sluggish economic growth, Signet's share price has grown by more than 600% over the last five years compared to 100% for the S&P 500 index. Signet has also managed to grow sales by roughly 5% every year for the same period. The engagement and marriage markets will continue to perform regardless of economic conditions because people will still want to get engaged or married.

In fact, weak or uncertain economic conditions are good for companies like Signet whose products are much more affordable than premium jewelers like Tiffany. Of course, everyone benefits from a strong economy because of the increased spending on jewelry.

How Signet benefits
It would appear that the timing of the acquisition is opportune, given Zale just recently returned to profitability. Its operating margin of 2.4% is still well below the 13% Signet churns out. However, Zale's margin of 2.4% is significantly better than the negative figure of 7% reported three years ago. Signet can also accelerate earnings growth by using its superior expertise in marketing and branding.

Signet reported strong first-quarter results with 6.3% growth in revenue, coming in at $1.06 billion and in line with consensus estimates. Earnings per share at $1.29 were ahead of the consensus of $1.27 a share and up 14% over the previous year. Zale reported mixed results including revenue of $431 million against a forecast of $442 million and a large jump in EPS to $0.32 a share compared to $0.13 in the previous year and well ahead of consensus estimates of $0.17 a share.

Bottom line
The jewelry market is a high-end retail market that remains somewhat insulated from the broader economy. Given Signet is now the dominant presence in the jewelry market, this jeweler could be one of the best plays in the the high-end retail market.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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