How Sustainable are Signet Jewelers’ Revenue and Dividend Growth?

For the last 5 years, Signet Jewelers (SIG) has outperformed the S&P 500 by a wide margin.

From Yahoo! Finance. Click image to enlarge.
From Yahoo! Finance. Click image to enlarge.

More importantly to us, Signet Jewelers has grown their quarterly dividend by a compound annual growth rate of 17% over the last 5 years.

From S&P Capital IQ. Click image to enlarge.
From S&P Capital IQ. Click image to enlarge.

Signet currently yields 0.85% which is low. However, low yields haven’t stopped us from investing in dividend growers like Visa (V) and MasterCard (MA). We’re more interested in Signet’s ability to keep growing their dividend at a high rate.

Issues raised this weekend in Barron’s by Herb Greenberg and Donn Vickrey of Pacific Square Research question the quality of Signet’s recent growth.

Vickrey: Their core U.S. business has always had a pretty significant reliance on credit. But about 18 months ago, they made a change to their “credit decision engine”—their words, not mine—and somehow it enabled them to increase the number of people they are loaning money to.

Your report says “credit participation” went to an all-time high of 63% of sales.

Vickrey: And immediately after that, their comp-store sales received a nice boost. The company says they haven’t changed their credit standards, but they admit that the credit mix has changed. Low-quality borrowers are borrowing more than higher-quality borrowers.

 

According to Pacific Square Research, Signet has also changed the way it measures underperforming loans and how it recognizes revenue. Two more red flags.

Vickrey: The majority of companies that offer consumer financing use what is called the “contractual method” for deciding whether a loan is nonperforming and subject to being written off. If your payment is $100 and you pay $100, you are OK. But Signet uses the “recency method”; even if a client pays less than $100, the company decides whether to call it nonperforming.

When you do use the recency method, it tends to understate your nonperforming loans. And even though they are using the recency method, charge-offs increased like 23% over the trailing 12 months. Then, right about the time their change in their “credit decision engine” anniversaried, exhausting the benefit to comps, they made a change to revenue recognition for their extended service business.

The issues raised have Signet boosting revenue with unsustainable one-time accounting gains. Future growth compared to its recent past will be tough. The worst case is Signet has expanded too much credit to too many risky borrowers. If these borrowers start defaulting at high rates it would harm the company. Both scenarios affect Signet’s ability to grow its dividend at a high rate.

Signet’s payout ratio is 16% so the dividend is protected but there are too many red flags for us to be interested in Signet as a dividend grower. There are always other opportunities.

Source:

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