Signet Jewelers (SIG 2.15%), one of the largest jewelry retailers in the United States, has made an important change to its business, reducing a major operational risk. But the company still has material, and outsized, exposure to a specific niche of the jewelry market that is causing some trouble today. It is making a big bet that could be a huge win if it works out, but a major ongoing headwind if it doesn't. Here's what you need to know.
Getting out of a risky business
Signet sells luxury items that tend to cost a lot of money. Many people choose to finance their jewelry purchases over time instead of paying all at once. In years past, Signet had a finance division that helped its customers do just that. The problem with this approach is that in economic hard times (such as recessions), an increasing number of customers will stop paying their loans. Signet and its shareholders had to eat the losses.
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In some ways, Signet was actually a stealth finance company. As it sold more jewelry, the finance division's importance grew. It wasn't a great story, and the risks eventually outweighed the rewards. The company decided to get out of the finance business, which was probably the right move. At the same time, it has been working to streamline its store operations (closing underperforming locations), further enhancing the company's chances of long-term success.
Today Signet is a more resilient operation that is less susceptible to economic swings. Sure, sales will drop when consumers are stressed, but the company won't have to deal with loan losses on top of that. Yet there's still a big risk here.
How much is riding on this?
The broader jewelry industry generates about 20% of revenue from wedding-related sales. That's a sizable figure, but Signet's exposure to this product category is a huge 50%! Basically, after getting out from under the financing risks it faced, management has now leveraged itself to just one type of jewelry.
That's been a headwind of late. After low single-digit growth in engagements between 2014 and 2017, engagements fell in the low single digits between 2018 and 2021. Small ups and downs over time probably aren't such a big deal, but engagements plunged by around 10% in 2022. Signet believes that the social distancing related to the coronavirus pandemic had a lot to do with that, since it upended normal dating patterns. The company expects another major decline in 2023 as well.
So, right now having 50% of its business tied to wedding jewelry is not a good thing. But Signet believes that demand for wedding jewelry will return in 2024 in a very big way. It is projecting three years of high single-digit to low double-digit demand growth, with a 25% overall increase over the entire period. If that comes to pass, the company's financial results will likely see a very sizable increase.
The risk is that the expected upturn in wedding jewelry demand won't materialize as expected. Notably, first-quarter 2023 sales fell nearly 10% year over year, and the retailer lowered its full-year guidance. The reason basically boils down to a weak economic environment suppressing demand. That's completely reasonable, but it is hard to believe that the same effect won't be felt with regard to wedding jewelry. So not only does Signet need a change in consumer habits on the wedding front, but it also needs the economy to be strong for its business repositioning to play out well.
A big bet
Signet's stock dropped after it reported Q1 earnings, but investors should probably continue to tread with caution here. A business recovery depends on just one line of products selling very well, but that is reliant on multiple factors that are completely out of the company's control. Unless you have very strong feelings about wedding trends, you'll probably be better off waiting until there's a positive inflection in wedding jewelry demand before buying Signet.
