Signet Jewelers Ltd (SIG US) short interest has been climbing since November 2015 when it topped $300 million for the first time after averaging just $201 million in 2015 and $194 million in 2014. SIG short interest continued to grow and traded in a $500 - $700 million range for the first three quarters of 2016. Short interest has exploded in October, increasing 134% to $1.4 billion in less than 3 weeks.
Signet Jewelers is the largest retailer of diamond jewelry in the world, operating mainly in the U.S., U.K. and Canada and retailing under the Kay, Jared, Zales, H. Samuel and Ernest Jones store brands. Even with the recent acquisition of the Zales store brand, which pumped up gross in-store and e-commerce revenue figures, Signet has had to cut its EPS guidance $1.00 to $7.25-$7.55. Weaker jewelry sales due to a softer economy are offsetting a good portion of the synergies gained by the Zales acquisition. Short sellers are most fearful of Signet’s addition of a fifth “C” when customers purchase a diamond: Carat, Cut, Color, Clarity and now Credit.
Credit sales constitute over 60% of total purchases, and 75% of wedding/engagement sales, and are growing at 9% annually. With total sales growing at a less than 7% rate, Signet is relying more and more on relatively easy in-store financing to close sales and increase sales growth. In fact, more than a third of Signet’s revenues come from interest income on their customer credit balances rather than the sales of diamonds. In order to keep revenues growing, Signet may be forced to lower its credit standards even more in order to increase its customer base.
Signet’s in-store financing division has been busier than its diamond cutters with an increase of 5% in active accounts in addition to a 6% increase in outstanding balances. This growing ancillary revenue stream would be a welcome addition to Signet’s bottom line if not for the 10% net charge-off rate on its accounts, 5% higher than standard private label lenders, which will be negatively impacting revenue figures in future quarters. Signet’s 30 day delinquency rate is almost 16%, well above average, even though they use the less preferred and less oppressive “recency” and not “contractual” accounting method to characterize “late and current” customer payment status.
Signet is looking to increase its margins to 17% from 12% with cost and supply management across all of their retail stores but if it continues to boost revenues by simply by lowering its financing standards and financing rates in its in-store credit division it may become the first “subprime jeweler” and face the same consequences as mortgage lender Countrywide Financial. Short sellers aren’t slowing down as the S3 Velocity Indicator, a measure of the real-time relative change in shorting activity, shows all three trend lines (7, 30 and 90 day) moving higher, indicating short selling momentum is still strong and Signet’s short interest balances should continue to grow.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC Ihor.Dusaniwsky@S3Partners.net
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