Sometimes, answering the question of whether a stock represents a legitimate, attractive value opportunity can be hard to do.
A company could be struggling to grow its business, and as a result be forced to restructure its business in a way that makes most of the traditional measurables investors like to use look very unfavorable. Strict, quantitative value and fundamental analysis would dictate that you stick to the numbers, and that you distrust anything but what the numbers tell you. That isn’t always the most sensible thing to do, however, simply because business isn’t always just about the numbers.
It isn’t that the numbers – sales, earnings, free cash flow, debt, and so on – aren’t important, because of course they always are. They help to frame a company’s business over any given period of time in a useful context. Sometimes, however, you also need to be able to look beyond the limits of what that context may describe. It can be important to remember that the numbers that make up fundamental and value-based metrics are almost always historical in nature; even forward-looking measurements and estimates are generally forced rely to some extent on past performance to provide a framework for what a company might be able to do in the future. This is really where one of the challenges of stock market and value-based analysis is greatest, because this is really more art than science.
To add even more complication to the mix, broader economic conditions naturally play a role in this analysis. Some segments of the economy are more sensitive to the ebb and flow of economic growth, and so a smart investor tries to understand where the stock you may be considering fits into the overall economic picture. If you’re paying attention to stocks in the Energy sector, for example, you need to understand that in the broadest sense, these stocks are tied directly to crude oil, natural gas, and other energy-related commodity prices. Stocks in the Consumer Staples sector, on the other hand, like Food Products tend to be a bit less sensitive to economic fluctuations simply because even when the economy may be contracting, consumers still have to stock their pantries and fridges.
With the idea of economic cyclicality in mind, let’s think about the Consumer Discretionary sector. This is a sector that tends to be more sensitive to broad economic conditions, and if you drill into some of the industries in the sector, you start to understand why that tends to the case. The Specialty Retail industry takes in a pretty wide swath of company types that includes the kinds of focused, specialized retail stores you’ll commonly find at the mall. Even more to the point, when you start thinking about specialists like jewelers, I think the picture becomes even more clear. When factors like unemployment are high, and incomes are dropping, shopping for diamond jewelry becomes a lot harder for the average consumer.
2022 has marked a change from the very accommodative monetary policy the Fed has used throughout the past two years to support the economy during the COVID-19 pandemic. As consumer activity has increased, consumer prices have risen faster than many expected, marking inflationary levels that haven’t been seen in the last 40 years. To add fuel to the inflation fire, Russia’s invasion of Ukraine has put additional constraints on energy supply, keeping prices for those energy products elevated and causing an inflationary ripple effect that has been extending into other sectors of the economy as well..
For specialty retailers like Signet Jewelers Ltd (SIG), the likelihood that inflation will remain high – and that interest rates will continue rising through the rest of the year means that these stocks may be exposed to a higher level of broad market risk than other stocks. That is part of the reason that the stock has dropped more than -52% from its November 2021 high at around $112. This is a company with a fortress-level balance sheet that features very low, manageable debt and healthy liquidity as well as Free Cash Flow, but that also has some holes in its fundamental profile that are a concern. The real question now is whether the stock’s big drop since November of last might translate to a useful value now. If it does, do broader market and economic conditions justify the risk? Let’s try to find out.
Fundamental and Value Profile
Signet Jewelers Limited is a Bermuda-based retailer of diamond jewelry. The Company operates approximately 2,800 stores primarily under the name brands of Kay Jewelers, Zales, Jared, H.Samuel, Ernest Jones, Peoples Jewellers, Banter by Piercing Pagoda, JamesAllen.com, Diamonds Direct and Rocksbox. It offer clients an unmatched range of products in rounds, pears, marquise, princess, emerald, cushion and heart shaped diamonds.SIG’s current market cap is $2.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 28.25%, while sales improved by almost 9%. In the last quarter, earnings declined by nearly -43%, while sales were -34.6% lower. The company’s historically narrow operating profile has not only narrowed, but dropped to negative territory in the last quarter. Over the last twelve months, Net Income was 4.89% of Revenues, and deteriorated in the last quarter to -4.54%.
Free Cash Flow: SIG’s free cash flow is very attractive, at about $821.6 million for the trailing twelve month period; that translates to a Free Cash Flow yield of almost 31%. It does mark a decline from $1.1 billion in the last quarter, and, but has declined from $1.5 a year ago.
Debt to Equity: SIG has a debt/equity ratio of .12, which indicates the company employs a conservative philosophy about leverage and speaks in part to the company’s fortress-level balance sheet. For perspective, consider that in late 2018, SIG held only about $134 million in cash and liquid assets versus $671.1 million in long-term debt. As of the last quarter, cash and liquid assets were a little over $927.6 million while long-term debt was just $147 million – down from $1.03 billion to begin 2021. It appears clear that management borrowed heavily at the beginning of 2020 to bolster its balance sheet against the broader declines it anticipated in the wake of the pandemic, as long-term debt jumped from a little over $500 million at the beginning of 2020 to a peak two quarters later at $1.33 billion. Considering that practically all of those obligations are no longer on the books, it’s easy to see why SIG’s balance sheet offers a significant sign of strength.
Dividend: SIG suspended its dividend in early 2020 to preserve cash, but reinstated it in mid-2021 at a rate of $.72 per share, and increased it to $.80 per share, per annum earlier this year. That is modest, translating to an annualized yield of 1.49%, but the reinstatement, followed by increase is still a declaration of management’s confidence in the future.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term target at about $54 per share. That suggests that the stock is fairly valued right now, with a practical discount price sitting at around $43.50 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above traces the stock’s price activity over the last year. The red diagonal line traces the stock’s downward trend from its high at $112 last November to its low in May at around $48. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock rallied in the first part of June to a peak at around $68, but has followed the broad market’s bearish momentum back down since then, and is approaching expected, current support at the 52-week, $48 low price. Immediate resistance is around $56. A drop below $48 should find next support at around $45 based on pivot activity seen in early 2021, while a push above $56 should find next resistance at around $61 based on the stock’s recent peak last month.
Near-term Keys: The stock’s downward trend has begun to show signs of consolidation in the last month, which could be a very early sign of a pending bullish reversal – but it would also be very speculative to plan a bullish trade on that basis alone. You could use a push above $56 as signal to buy the stock or work with call options, with a bullish target at around $61. A drop below $48 would be a bearish signal to consider shorting the stock or buying put options, with downside to about $45. What about the value proposition? While some of the company’s fundamentals, such as its balance sheet, are very strong, there are also concerns in the form of declining Free Cash Flow and negative Net Income in the last quarter that I think are significant enough to accept the fact that a useful value proposition simply doesn’t exist right now. With current conditions as they are, I think the smart approach for a value investor is to tuck SIG onto a watchlist and come back to it later.