Signet Jewelers Ltd. (SIG): This Stock Can Add Shine to Your Portfolio

Most people might cut back on discretionary spending for their own pleasure when times are bad, but tend to still show their appreciation for their loved ones. The stellar financial track record of Signet Jewelers Ltd. (NYSE:SIG), the largest specialty jeweler in the U.S. and the U.K., bears testimony to the resilience of bridal purchases and gift giving. Signet has an edge over competitors with its in-house credit program, and has plans in place to enhance its U.K. margins. Signet Jewelers Ltd. (NYSE:SIG) represents a compelling value proposition, trading at a significant discount to its peers.

Resilient business with unique buying behaviour

Signet Jewelers Ltd. (NYSE:SIG)’s customers buy jewelry for two major reasons: weddings & anniversaries and gift giving. There is a certain element of resilience associated with these type of purchases. Holidays and birthdays are spread out through the calendar year, providing customers with the necessary ‘justification’ to spend on gifts for family and friends. In contrast, other consumer discretionary purchases, such as cars and consumer electronics, tend to be either impulse purchases or new product-driven. Also, since weddings are typically planned in advance, there tends to be a lag effect with respect to deferred weddings, which provides buffer for reduced gift purchases or downgrades to lower price points during bad times.

The financial numbers lend support to this argument. Signet Jewelers Ltd. (NYSE:SIG) has delivered positive earnings and free cash flow in nine out of the past 10 years, and also grew revenue and EPS by a 10-year CAGR of 4.2% and 5.8%, respectively.

In-house credit provides an edge

Anyone who is married knows the amount of time, effort, and money required to make the wedding a memorable affair. Similar to retailers which provide in-house credit for newly weds’ purchases of home appliances and furniture for their new home, couples who are operating on a tight budget on their wedding will definitely appreciate some form of financial aid to buy the most sparking diamonds to make the bride look gorgeous.

According to its most recent 10-K, in-house credit sales accounted for 56% of Signet Jewelers Ltd. (NYSE:SIG)’s U.S. sales for the past two fiscal years, reflecting the significant amount of customers attracted to and relying on its in-house credit. In-house credit provided by retailers is becoming increasingly important, with a significant number of Americans being either unbanked and under banked.

In addition, Signet’s customers are able to get their credit approved online or at in-store terminals. Management also estimated at its recent earnings conference call that the lifetime value of a credit customer is more than three times greater than that of a non-credit customer. This is hardly surprising, as lender-borrower relationships tend to be sticky and breed customer loyalty.

Getting U.K. back in shape

U.K. accounts for around one-fifth of Signet’s revenue, but below one-tenth of its operating income. Signet targets to increase its U.K. operating margins to 10% by fiscal 2015 by improving product mix, reducing overheads, and optimizing its real estate portfolio. With respect to the last point, Signet outlined plans at its recent investor conference to relocate some of its stores in the U.K. to more suitable areas to enhance traffic conversion rates.

Peer comparison

Signet’s peers include Tiffany & Co. (NYSE:TIF) and Blue Nile Inc (NASDAQ:NILE)

Like all other luxury retailers, Tiffany faces a Catch-22 situation, where it has to decide between maintaining price points to protect its brand image, or lowering price points to expand its customer base. At its fiscal 2012 earnings conference call, Tiffany mentioned that it will introduce new designs in 2013 with entry-level price points below $500, which is likely a response to critics that it has not focused sufficiently on the lower price segment. I would have preferred Tiffany & Co. (NYSE:TIF) to maintain its focus on high-end jewelry segment to avoid brand dilution.