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Signet Jewelers Ltd. Could Be a Diamond, But It’s Still in the Rough

Long-term fundamentals are improving for Signet, but near-term valuation is now a concern

Signet stock - Signet Jewelers Ltd. Could Be a Diamond, But It’s Still in the Rough

Source: Elizabeth Murphy via Flickr

In mid-March, Jewelry retailer Signet Jewelers Ltd. (NYSE:SIG) reported slightly better-than-expected quarterly numbers which were accompanied by a huge turnaround plan that required a ton of investment, was projected to kill earnings, and spooked investors.

Signet stock dropped. Big time. From nearly $50 to below $40.

I thought that big dip in Signet stock was a buying opportunity. After all, demand for Signet’s portfolio of mid-price jewelry will always be strong. Signet has just had trouble capitalizing on that enduring demand over the past several years. But a new turnaround plan, which focuses on modernizing the business through enhanced omni-channel capabilities, will get Signet back on track and allow the company to fully capitalize on secular demand for mid-price jewelry.

Fast forward a few months. Signet just reported a robust double-beat quarter which underscores that the aforementioned turnaround plan is off to a red-hot start.

As a result, Signet stock has soared not just back to $50, but all the way up to $55.

Does this rally have more gas in the tank?

Long-term, yes. Short-term, no. At $55, Signet stock seems slightly overvalued considering the company’s still low-growth prospects and persistent margin headwinds.

As such, while I was a buyer below $40, I am now a seller at $55.

Here’s a deeper look:

Signet’s Quarter Affirms Turnaround & Long Term Upside

From most perspectives, Signet’s quarter was quite good.

Comparable sales growth was essentially flat. Although that might seem unimpressive, that is a huge relief for Signet investors who have been accustomed to negative comparable sales growth for the past two years.

And the declines haven’t been small. Last quarter, comparable sales dropped more than 5%. In the year ago quarter, they dropped nearly 12%. From this perspective, a flat comp is a huge thing for Signet. It implies that, indeed, things are getting better.

Granted, comparable sales are still expected to fall in the low- to mid- single-digit range for the full-year, but I suspect that guide will prove to be ultimately conservative. This is a turnaround plan, and it would be an awful look for management to under-perform expectations in the middle of a turnaround. On the flip-side, it would be a great look for management to over-perform expectations during this turnaround.

Consequently, I think management is abiding by the “under-promise, over-deliver” mantra, and as such, further think that comparable sales growth this year will be closer to the flat-line than most think.

Margins are getting killed. But we all expected that. The company is phasing out its credit business, closing stores, integrating James Allen (which has lower gross margins), and pouring money into its e-commerce channel. The sum of these changes will vastly improve and simplify Signet’s operating model in the long-term. But in the meantime, margins will get killed as these changes require capital.

All together, the quarter affirmed that Signet isn’t a dying brand. Just a struggling one. The company will climb out of this hole, boost its omni-channel presence, and ultimately continue to sell mid-price diamonds to consumers everywhere for a long, long time. Revenues will grind slowly higher, and margins will bounce back, the combination of which should drive a higher share price in a multi-year window.

Signet Stock Is Worth $50, Not $55

At the present moment, though, Signet stock seems slightly overvalued.

It is important to note that heading into the report, more than 15% of the float was short, meaning that a lot of people were betting on this turnaround not shaking out well. They were wrong, and are now probably scrambling to cover their short positions. That means that Signet stock’s huge post-earnings rally is partially driven by some short-covering.

By my numbers, this volume short-covering has caused the rally in Signet stock to go too far, too fast.

Revenue trends are stabilizing. But they aren’t pointing to growth any time soon. At best, this is a 0-1% revenue growth narrative over the next several years. Meanwhile, margins will bounce back, but operating margins will never get back to their 10%-plus highs because the credit business is gone, the lower-margin e-commerce business is ramping, and the company will likely continue to be forced to spend big on advertising in order to remain relevant.

All together, this is a company with nearly flat top-line growth prospects and some, but not a lot, of room for margins to rebound. Under those assumptions, I think that Signet can net around $5.20 in earnings per share in 5 years.

A historically-average and value stock-average 14-times forward earnings multiple on $5.20 implies a four-year forward price target of $73. Discounted back by 10% per year, that equates to a present-day value of $50.

Bottom Line on SIG Stock

The turnaround is off to a good start. But the stock price now appropriately reflects this reality. As such, asymmetry no longer skews towards the upside, and profit-taking looks like the right move here and now.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/2018/06/signet-jewelers-ltd-could-be-a-diamond-but-its-still-in-the-rough/.

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