Luxury Retailer With Strong Brand Equity and Growth Prospects

By Sandeep Gupta - September 13, 2012 | Tickers: NILE, FOSL, SKS, TIF, ZLC | 0 Comments

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In the face of a weak macro environment, luxury retailers are having a hard time. Over the past 5 years, specialty jewelry retailers including Blue Nile (NASDAQ: NILE) and Zale Corporation (NYSE: ZLC) have made huge losses. However, Tiffany & Co. (NYSE: TIF) is among a few specialty jewelry retailers to have posted double-digit annual growth over the last five years. The following chart summarizes the growth of these companies over the past five years.

Last month, Tiffany reported its Q2 results with EPS of $0.72 missing the consensus estimates by a penny. While Q2 same store sales were down 1%, I will take that as Tiffany was up against the toughest year ago comparisons in Q2 (vs. 28% SSS in 2Q11). The reaction in the shares to a miss and a reduction to guidance suggests there was a lot of fear heading into the report. However, Q4 is likely to be a better quarter as easy comparisons, new products, and new marketing could support strong results. Moreover, the decline in prices of Gold, platinum, and silver prices should begin to flow through and gross margin expansion is likely in Q4. While this year is relatively difficult for the company, the long-term strategy is intact and we do believe growth will reaccelerate next year.

Focusing on what can be controlled

Tiffany has been persistent in introducing new products and collections. The recent product development efforts have been very successful and it appears that the company is planning to expand into watches. I believe this a positive move and expect Tiffany to gain some market share from competitor Fossil (NASDAQ: FOSL) who has seen a huge growth in the segment. Moreover, China represents attractive long term growth prospects with a rapidly growing luxury watch market. I am confident that the company will have rebalanced its price points and improved the flow of new product into 4Q. Accelerated new store openings including Prague, 5 Emirates and the New York Soho store should fuel incremental sales. Four Holt Renfrew stores in Canada will now be controlled by Tiffany who will report the sales versus the previous wholesale relationship. I also anticipate accelerated advertising surrounding its 175th anniversary into 4Q. I believe that these initiatives will act as growth strong drivers.

Leveraging Capital Investments

Tiffany, in order to maintain a constant supply of high-quality diamonds, directly sources over half of its rough diamonds. The company now manufactures roughly 60% of its products in 10 facilities, up from roughly 20% in the mid-1990s. I expect that number to climb up to 70% in the coming years. While the current retail environment is challenging, but over the longer term, I believe Tiffany is well positioned to support solid sales and earnings growth through leveraging capital investments made over the past several years in distribution, manufacturing, and diamond sourcing processes. With over half of total revenue generated outside of the U.S. region in 2010 and 2011, I believe Tiffany is well diversified from a regional perspective, as well.

Inspirational Brand Equity

The company has done an impressive job maintaining the highest level of brand equity and safeguarding the little blue box's inspirational appeal, while at the same time staying relevant to its core customer base. According to a survey conducted by the Luxury Institute, Tiffany is the most popular luxury jeweler: 13% of ultra-wealthy shoppers made a blue box purchase in the past year; 75% plan to buy Tiffany goods in the coming year. Tiffany is the most popular among the 100 plus brands mentioned by high-end consumers for made to order, one of a kind, and made to measure luxury goods.

Tiffany is trading at a forward P/E of 15.04, which is at a healthy discount to Saks (NYSE: SKS). I believe a 28% discount to Saks is unjustified because Saks poses a greater risk to declining high-end domestic spending given its greater dependence on domestic customers with respect to Tiffany which generates about 50% of its sales overseas. With the worldwide millionaire population is expected to grow 73% by 2020 and spending growth luxury consumption is expected to grow 7%-10% annually from 2011 to 2014, I expect Tiffany's strong brand equity to drive an accelerated demand over long term. Thus, I am bullish on this stock and recommend buying it.

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