SIG: value stock, or value trap?

October 11, 2018

SIG: value stock, or value trap?

Sometimes, answering the question of whether a stock represents a legitimate, attractive value opportunity can be hard to do. A company could be struggling not only to grow its business, but may 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 measurements are almost always historical in nature; even forward-looking measurements and estimates tend to rely 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.



It might sound like I’m talking about trusting your gut, or being willing to compromise on some of the fundamental criteria you usually use to guide your investment decisions, but I don’t really like to do either of those things. As an investor, my gut tends to be wrong more often than it’s right; that is one of the reasons that over the course of my investing career I moved away from even more subjective, low-probability methods like short-term swing, trend or momentum trading. And giving in to the temptation to make allowances for poorer measurables is an emotional response that will make it harder to think objectively about what you should do if the time comes to call a bad investment what it really is. All that said, I do think that there are cases from time to time where a stock’s fundamental strength or value opportunity is hard to quantify by measurables alone.

Signet Jewelers Ltd (SIG) is an interesting example of what I mean. This is a stock that, over the last six months, has increased in value more than 81% as of this writing, which has made it something of a darling to a lot of talking heads. Since early 2016, however, the stock is down more than 60% from an all-time high at around $150 per share despite its increase since April from a low at around $33 per share. Technically  speaking, that could be a very good thing, since the stock’s long-term downward trend appears to be reversing and building a base for a new potential long-term upward trend. Fundamentally speaking, the company’s measurable statistics are pretty mixed; there are some that are clearly optimistic, while others paint a more troublesome picture. Added to that backdrop is a value-based analysis that looks incredibly attractive, and splashed against all of that is a company in the midst of a major transformation effort. Sound confusing? You bet. Does that make the stock an overall terrific value, or a high-risk value trap? You decide.



Fundamental and Value Profile

Signet Jewelers Limited is a retailer of diamond jewelry. The Company’s segments include the Sterling Jewelers division; the Zale division, which consists of the Zale Jewelry and Piercing Pagoda segments; the UK Jewelry division, and Other. The Sterling Jewelers division’s stores operate in the United States principally as Kay Jewelers (Kay), Kay Jewelers Outlet, Jared The Galleria Of Jewelry (Jared) and Jared Vault. The Zale division operates jewelry stores (Zale Jewelry) and kiosks (Piercing Pagoda), located primarily in shopping malls across the United States, Canada and Puerto Rico. Zale Jewelry includes the United States store brand, Zales, and the Canadian store brand, Peoples Jewellers. Piercing Pagoda operates through mall-based kiosks. The UK Jewelry division operates stores in the United Kingdom, Republic of Ireland and Channel Islands. The Other segment includes the operations of subsidiaries involved in the purchasing and conversion of rough diamonds to polished stones. SIG’s current market cap is $3.1 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings decreased a little over 60%, while sales growth saw a negligible increase of about 1.5%. The picture is reversed in the last quarter, where earnings more than quadrupled, while sales declined 4%. The company is currently operating with negative Net Income on both an annual and quarterly basis, although the percentage of Net Income to Revenues improved to the positive in the last quarter, from -2.7% to -1.6%. This is a reflection, at least partly, of a multifaceted transformation effort that has included SIG selling their in-store credit business, acquiring R2Net to enhance the company’s digital technology capabilities and move the company away from its present, heavy reliance on mall-attached stores. That effort includes strategic store closures and an ongoing push towards ecommerce that is expected to represent 15% of revenues by 2021.
  • Free Cash Flow: SIG’s free cash flow is very attractive, at more than $1.8 billion for the trailing twelve month period; that translates to a Free Cash Flow yield of more than 51% and that provides some relief from the company’s troubling margin profile.
  • Debt to Equity: SIG has a debt/equity ratio of .48, which is a low number that indicates the company operates with a generally conservative philosophy about leverage. Of concern is the reality that as of the last quarter, SIG held only about $134 million in cash and liquid assets versus $671.1 million in long-term debt.
  • Dividend: SIG pays an annual dividend of $1.48 per share, which translates to a yield of 2.47% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SIG is $26.98 per share and translates to a Price/Book ratio of 2.22 at the stock’s current price. Their historical Price/Book average is 2.92, which suggests that the stock is trading at a discount right now of about 31.5%. Their Price/Cash Flow ratio offers an even more optimistic perspective, since it is currently running 117% below its historical averages. Between the two measurements, the long-term target price, based strictly off of value analysis could lie anywhere in a range between $78 and $129 per share. It is also worth noting here that the stock’s Book Value has declined by nearly 35% in the last two quarters. I attribute a large portion of the change to the company’s sale of its in-house credit business in late 2017, which yielded more than $900 billion that helped management cut its long-term debt by more than half.



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 downward trend over the last two years to its low in April of this year at around $33, and its increase to date from that point. It also provides the basis for the Fibonacci retracement lines shown on the right side of the chart. The stock’s upward trend for the last six months covers and intermediate period of time and is the basis for the idea that the stock is forming a useful base to stage a larger, long-term bullish trend reversal. Currently the stock is sitting practically on top of support at the 38.2% retracement line, with resistance right around $67 from previous pivot highs. The stock would need to break that resistance level to extend its current upward trend further. A break below support at around $59 per share could see the stock drop quickly to the $48 to $50 range; a continued drop from that point would represent a reassertion by the long-term downward trend of bearish strength, and which could push the stock back to test its trend lows in the mid-$30 range.
  • Near-term Keys: The stock’s strong intermediate bullish trend pattern, along with the outsized value proposition make this a tempting stock to consider using for a bullish trade. If the stock can pivot back to the upside, a break above $67 per share should see it push fairly easily into the $75 range. The risk, of course is if the stock breaks below $59 per share. That should be taken as a strong bearish signal, and could offer some interesting opportunities to short the stock or work with put options. From a long-term, value perspective, it may be hard to justify taking a new position in this stock right now; I would prefer to wait until future earnings reports demonstrate continued traction being seen in the company’s transformation plan, with measurable increases in Net Income and Cash.