Signet Jewelers (NYSE:SIG) has built itself into the country's largest specialty retailer of jewelry by being a one-stop shop for the middle class. It offers products at a range of price points through its Jared and Kay brands. Its ability to leverage its size and scale has led to consistent profit improvement, which has boded well for existing shareholders who have enjoyed a strong five-year stock price run.
However, the company apparently sees further benefits in a larger market presence, recently agreeing to buy smaller competitor Zale (UNKNOWN:ZLC.DL) for roughly $700 million. So, is Signet still a good bet for investors?
What's the value?
Signet has an unmatched footprint in the U.S., operating a network of almost 2,000 stores that cover all 50 states; this is complemented by a leading presence in the U.K. market. While the company's forte is relatively inexpensive jewelry, as evidenced by an average transaction price of around $400 at its Kay unit, its ownership of the Jared upscale chain allows the company to hold on to customers as they move to higher price points in their desired purchases.
Signet also takes advantage of its strong financial profile to extend financing to a majority of customers, approximately 60%. This provides a high-margin source of income to supplement its retail operations.
In its latest fiscal year, Signet continued building on its multiyear expansion story. It reported a 5.7% top-line gain that was aided by an increase in comparable-store sales in its U.S. and U.K. segments as well as marginal additions to its overall store base.
While the company's merchandise margin contracted slightly, Signet kept its overhead costs relatively in check. This allowed it to maintain a healthy double-digit operating margin. The net result for Signet was a continuation of solid operating cash flow, providing the foundation to fund growth in its customer financing programs.
Getting rid of the competition
Of course, Signet's acquisition of Zale is a smart move; it eliminates a major competitor that anecdotally had a presence in many of the same malls that its Kay unit calls home. More important, Signet should be able to achieve much better profitability for the Zale operation through leveraging the combined company's buying power and eliminating duplicate corporate functions; these are areas where management expects post-transaction cost savings of roughly $100 million.
Zale had been a feel-good story over the past few years as it tried to rebound from a near-death experience caused by a host of factors, not the least of which was an over-leveraged balance sheet. A debt-financing package by retail-focused investment firm Golden Gate Capital in 2010 provided the necessary breathing room for Zale, albeit at a hefty cost. It also gave the company time to improve its cost structure, leading to a return to operating profitability in 2012.
Being part of the Signet family will obviously eliminate business funding concerns for Zale. It will also allow the company to focus on continuing to produce great products, like its popular Vera Wang Love and Celebration Diamond product lines.
Looking for growth opportunities
Signet is an intriguing story as it assimilates Zale's store base into its own operations. But the company's future organic growth trajectory seems limited at best given its existing presence in seemingly every domestic market of interest. As such, its current valuation seems a bit rich, at an above-market P/E multiple of 23, especially after a nearly 60% stock price run over the past 12 months. Alternatively, investors might want to take a look at a retail jewelry story with greater potential growth opportunities, like Tiffany (NYSE:TIF).
The operator of upscale jewelry stores had a solid year in FY 2013, reporting a 6.2% top-line gain that was primarily a function of higher comparable-store sales across its major geographic regions. More important, Tiffany generated a higher merchandise margin. This was thanks to the dual positive effects of a better pricing environment and moderating commodity costs, which led to improved operating profitability after adjusting for the effect of a legal settlement.
The net result for Tiffany was twofold: greater funding for its product development efforts and a further expansion of its store network in the Asia-Pacific region, a primary focus area for the company over the long term.
The bottom line
Signet is certain to have created value with its pending acquisition of Zale, but new investors may be a little late after a nearly 25% jump in the shares since the mid-February announcement. A better bet in the jewelry space may be Tiffany; it had a better growth profile than Signet in FY 2013 and is well positioned to capture international growth with its expanding store base around the world.