In December 2016, I wrote an article about Signet (SIG, Financial) with a pretty dumb title. To be fair, I think it was tongue in cheek after reading Bill Ackman (Trades, Portfolio) talk up Valeant Pharmaceuticals (VRX, Financial). However, over a year later, the company is still grappling with sexual harassment and discrimination allegations. Now with the stock four points off its year low, down 30% in the last year, it is time to dollar cost average.
With a forward price to earnings ratio below 9x, the company still expects to earn over $12 a share in the next two years. It is the Luxottica of the jewelry business with a strangle hold on retail shopping through Jared, Kay and Zales.
It’s true that the media surrounding the company may be unfavorable, but how long can the bad taste last? The company is already moving on. Former CEO Mark Light’s tenure was marked by a class-action arbitration case in which 69,000 women who worked for a Signet subsidiary, Sterling Jewelers, alleged that the company discriminated against them in pay and promotion practices. He was replaced last year by Virginia Drosos, who has served on the company’s board since 2012.
Despite the change, the stock price has been volatile, even hitting $76 back in November. My thesis is simple. People will still buy jewelry from Signet-owned brands. Jewelry prices will continue to rise. If Signet remains the leader (highly likely), the company’s profits will rise too.
If this was a private business selling for 1.9x cash flow, you’d be stupid not to buy it because the long-term risk would be almost zero. Signet generated $1.8 billion in cash flow in the last year with a 20% return on equity, 7% return on assets and a much lower tax rate now -- thank you Donald Trump. However, since its stock is traded on the open market, the advantage of higher multiples is mitigated by the media influence on your value.
When Signet reported its holiday sales results, the nine weeks ended Dec. 30 saw total sales decline 3.1% year-over-year, and same-store sales fall 5.3%, including an 8.5% decline at the Sterling Jewelers brand. The company provided an update to its full-year fiscal 2017 guidance in light of U.S. tax reform. For the full year, earnings per share are pegged to land between $6.45 and $6.50, compared to the company’s preview guidance of $6.10 to $6.50.
Let’s say the company reports earnings of $6.45 a share with Gina Drosos demonstrating a strong ability to lead, and the short-sellers start to cover. The multiple could creep back to historical averages. At 18x earnings per share, investors would be sitting on a 120% profit. Even if sales and earnings stagnate for a few years, a multiple expansion could put the stock above $100.
From a trade management perspective, say you owned 100 shares at $90 at the beginning of last year. The same $9,000 investment at $52 would give you 230 shares total. If the company does successfully navigate the headwinds and profits are met with higher multiples, then just getting back to $90 would give you a 35% gain.
I think it’s only a matter of time. In the meantime, take the 2.38% dividend and wait for the next earnings call.
Disclosure: I am not long/short any stock mentioned in this article.
