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Sterne Agee Raises Outlook, Price Target on Signet

Feb 21, 2014 9:51 AM   By Jeff Miller
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RAPAPORT... Sterne Agee raised its rating outlook on Signet Jewelers to ''Buy,'' citing potential earnings per share (EPS) in excess of $11 by fiscal year 2017 compared with only $6.35  without the planned merger with Zale Corporation.  The firm believed that improvements from Zale's margins and productivity coupled with the benefits of Signet's best-in-class omni-channel processes would continue to attract investor interest during the next 24 months. Sterne Agee raised its price target on Signet to $120 per share. 

Shares in Zale opened flat this morning at $20.89 from their closing price on February 20, while Signet's shares were up about 1 percent to $95.06.

Signet agreed to buy Zale for $21 per share this week in a deal valued at about $1.4 billion due to the inclusion of roughly $500 million in debt held by Zale. Sterne Agee believes that presumed synergies between the two former rival jewelers may even prove to be conservative over the long term. signet, earnings

Signet anticipates generating  $100 million in post-merger operating synergies by its third full fiscal year, which is 2017, including $50 million savings from improved sourcing, $20 million by eliminating redundant sales and administration costs and another $30 million from incremental product margins. Sterne Agee added that Zale's credit agreement that begins in October 2015 will further reduce costs by $22 million, resulting in $122 million of total benefits to earnings before interest and tax (EBIT).

''We believe this number could prove conservative, not accounting for various levers, such as leverage on advertising and landlords, headcount reduction, distribution savings, etc., and total synergies could reach $175 million by our estimation,'' according to Sterne Agee's analyst, Ike Boruchow.

Boruchow added that after analyzing potential accretion from the acquisition, Zale could contribute an EPS of about $3.25 from operating performance alone, plus an additional $1.60 to $1.70 in operating synergies, resulting in 2017 EPS of $11 to $11.50.

''We believe Signet can accelerate the pace of Zale's  turnaround due to its expertise in marketing, sourcing, branded merchandise and consumer credit. As a result, we estimate mid- to high-single-digit comparable-store sales for Zale in the medium term, with operating margins eventually reaching about 13 percent (still below Signet's) due to a combination of gross margin improvement and leverage of fixed selling, general and administrative costs as productivity improves,'' Boruchow added.

The new Signet will represent approximately a 16 percent market share of the jewelry retail market in the U.S.; it is already the market leader in the U.K. and now it will become the largest player in Canada through Zale, all of which create a global platform that could support future geographic expansion, according to Sterne Agee.

''We examined a peer group of other retailers in healthy industries that have over 15 percent market share and the group's average over the next 12 months price-to-earnings ratio is very healthy (not surprisingly) at 18-times, with a minimum value of 15-times. Given Signet's now 16 percent U.S. share once the deal closes, we believe investors will need to start paying up for this best-in-class operator with multiple levers in the model to drive sales and margin growth,'' according to Boruchow.

Despite the optimistic outlook, Sterne Agee calls the current market for jewelry retailers ''choppy'' and it continues to define the first quarter of 2014 a ''tough start'' due to gross margin pressure,  incremental promotions and increased unadvertised discounting, together with adverse weather in some locations of the U.S.

''Despite these headwinds to start the year, we believe it will take a backseat to long-term accretion from the Zale acquisition and investors are likely to give the company a pass on any near-term operating weakness,'' he said.

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Tags: analysts, earnings, Jeff Miller, market share, merger, outlook, Signet, sterne agee, Zale
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