On Feb. 19, Mario Gabelli (Trades, Portfolio), the Chairman and Chief Executive Officer of GAMCO Investors Inc. added Zale Corp (ZLC, Financial) at an average price of $20.92 and currently holds 1,678,670 shares of the stock, worth 0.19% of his portfolio. That day, the stock price soared over 40% in response to news that it was being acquired by Signet Jewelers (SIG, Financial) for $21 per share.
So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity in a sub-industry that is characterized for being diverse, with a wide range from high-end stores selling luxury items such as jewelry, to those selling less discretionary items such as automotive parts.
Strategic Acquisition
Zale operates more than 1,000 retail jewelry stores and 600 kiosks throughout the U.S., Canada and Puerto Rico. The company’s business segments include: Fine Jewelry, which focuses on fine jewelry and watches; and Kiosk Jewelry, with focus on gold, silver and non-precious metal products.
Signet will acquire all outstanding shares of Zale at $21 per share. We have to remember that five years ago, shares traded below $1. Signet´s acquisition could create $100 million of costs synergies per year, which is an interesting number for the balance sheet. The deal will expand Signet's business in the U.S., as well as almost doubling its network. Shares of both companies skyrocketed on the news, showing that Wall Street values the deal.
Signet CEO, Michael Barnes, explained to MarketWatch the (40%) premium paid “It’s going to help us drive middle market with a lot of new merchandising. The brands are going to be a main driver. We think there’s a big opportunity for cross selling going forward.”
Other winner of the transaction was the hedge fund Golden Gate Capital, which bailed out Zale with $150 million some years ago, and now owns 22% of the company.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 294.1x, trading at a premium compared to an average of 18.3x for the industry. To use another metric, its price-to-book ratio of 4.6x indicates a premium versus the industry average of 1.69x and the price-to-sales ratio of 0.5x is below the industry average of 0.71x. The first two metrics indicate that the stock is relatively overvalued relative to its peers.
Earnings per share (EPS) increased by almost 11% in the most recent quarter compared to the same quarter a year ago and it has demonstrated a positive trend in the last 4 years. We include in the next graph the stock price because EPS often lead the stock price movement.
Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has increased when compared to its ROE from the same quarter one year prior. This is a signal of strength and is positive for investors. With a ROE of 5.4% is still below the industry mean of 9%. Competitor such as Tiffany & Co (TIF) will be a better option in terms of ROE.
Final Comment
Net income increased beating the industry and the S&P 500, demonstrating the improvement of the company´s strength. The bottom line earned $0.02vs -$0.96 in the prior year, and for this year, the market expects an improvement in earnings ($0.49 versus $0.02) which will be positive for investors.
The firm currently has a Zacks Rank #1 (Strong Buy) and I would recommend investors to consider adding the stock for their long-term portfolios. Hedge fund gurus have also been active in the company in Q4 2013. Steven Cohen (Trades, Portfolio) has also invested in it.
Disclosure: Damian Illia holds no position in any stocks mentioned.
