When shopping for jewelry, many shoppers might not be able to afford the little blue box that comes from Tiffany & Co. (NYSE: TIF). However, they might be familiar with the phrases "He Went to Jared" and "Every Kiss Begins With Kay."
Signet Jewelers (NYSE: SIG) announced earlier this year that it would acquire Zale Corp. (NYSE: ZLC). The move, which just cleared a regulatory hurdle, will bring together two of the largest jewelry retailers in the U.S. by market share.
Generally, the acquiring company sees a pullback in its stock, while the company being acquired rises. However, shares of both Signet and Zale are up over 30% since the announcement. The market has taken the acquisition as a big positive.
Signet could see the benefits of the acquisition even sooner than normally would be expected, considering the move gives it an even bigger lead over Tiffany in the U.S. jewelry retail market.
With the acquisition, Signet will be the jewelry market share leader in three countries. It's already the leader in the U.S. and the U.K. -- but it doesn't have a presence in Canada, which is where Zale happens to be the market leader. The deal should expand Signet's U.S. market share to over 15%, more than double what it had in 2003.
The one thing to like about the jewelry industry is that its products remain somewhat insulated from the broader economy. Over the past five years, Signet's shares have soared 650%, compared with the S&P 500's gain of 100%. So despite the decline in mall traffic and the weak global economy, Signet has been performing nicely: Sales have grown at an annualized rate of nearly 5% over the past half decade.
|Signet Jewelers Limited|
|With the acquisition of Zale Corp., Signet will be the jewelry market share leader in three countries, including the U.S. and Canada.|
Part of this comes as the engagement and bridal market performs well in a mixed economy. Regardless of how the economy's doing, people still get engaged and married. In fact, a weak economy, in which shoppers trade down from the likes of Tiffany, is a positive for Signet. Meanwhile, a strengthening economy is also a positive, as more consumers have the ability to buy fine jewelry.
Typically, the main category for jewelry is diamond rings. That remains the case. But it's worth nothing that other jewelry items have been strong for Signet, including watches. There's also a number of partnership opportunities. Signet already has items from Coach, Gucci and Michele in its stores. And as shoppers come in for these specific brands, Signet will have the opportunity to upsell them diamonds.
It also appears that Signet is snatching up Zale just as the business is improving. Zale's operating margin came in at only 2.4% in its last fiscal year, well below Signet's 13.6%. However, that 2.4% operating margin for Zale is a big improvement from the negative 7% we saw just three years ago.
In reality, Zale's performance has been weak for the past couple of years. Analysts have been dialing back their outlooks lately and now expect sales growth to be flat for the next few years. However, Zale's management expects revenues can grow at a mid-single-digit pace over the next couple of years. Signet should be able to accelerate earnings growth at Zale by using its expertise in marketing and branding to help make Zale a more efficient company.
Analysts have yet to revise their Signet earnings estimates to account for the Zale acquisition. This disconnect is offering investors an attractive buying opportunity. Total annual synergies are expected to be around $100 million. With the addition of earnings from Zale, a turnaround in Zale's performance, and cost savings, earnings per share (EPS) for Signet could come in as high as $7.25 for fiscal 2015.
Signet's historical average price-to-earnings (P/E) ratio is 12.5. However, the recent Zale merger puts Signet as an undisputed leader in the jewelry market. Signet deserves to trade at least in line with Tiffany. TIF is trading at a P/E of over 18 based on next year's earnings estimates -- but its return on investment is only 6%, while Signet's is upward of 14%.
Risks to Consider: If Tiffany gets more aggressive and decides to compete in the lower- to mid-market jewelry business, that could put pressure on Signet. Rising prices on gems and gold could put pressure on margins.
Action to Take --> Buy Signet while the market is still trying to understand the Zale acquisition. There's a big potential for earnings growth from the Zale acquisition over the next couple of years. A P/E ratio of 18 on 2015 expected earnings suggests a price target of $130 -- over 25% upside.