Proprietary Records
The company rejects the notion that it is taking on greater credit risks. The software used for credit decisions, it says, is built on decades’ worth of proprietary records on consumer behavior and provides a more refined method of scoring applicants. When asked about it during a conference call last month, Signet’s chief financial officer described the credit program as a “competitive advantage for the company.”
Likewise, Signet points to a change in operations to explain how it is booking upfront more income from warranties sold at Kay and Jared. For example, on a $150 warranty on a $1,500 diamond ring, 57 percent can be booked as income immediately. Until last May, the company booked only 45 percent of that $150 over the first two years.
The company says the shift stems from a decision to stop sizing rings for free in favor of wrapping that service into the purchase of a warranty. This accounting change added 7 cents a share to earnings in the second and third quarters combined.
Whether these practices might lead to greater losses is the core question for investors. The standard contractual method for determining whether an account is nonperforming is simple: Did the customer pay the minimum amount due within 90 days? Signet instead uses the recency method -- discouraged by the Federal Reserve for banking companies -- which allows it to keep listing a loan as performing if a borrower has made a substantial portion of the minimum payment.
Recency is one of two approaches allowed under generally accepted accounting principles, as Signet points out, though it is rarely used. For Marc Cohodes, a short-seller based in Penngrove, California, Signet’s credit strategy poses enough potential risks to rethink Signet’s 117 percent gain over the past five years, about double the advance in the S&P 500 Select Retail index. He’s shorting Signet.
“They don’t seem to have any wiggle room,” Cohodes says. “I view this company as a subprime financial lender dressed up as a retailer, which will one day lead to a substantial revaluation of the shares.”