Tiffany - Victim of Increasing Commodity Costs

By Maxwell Fisher - July 9, 2012 | Tickers: NILE, COH, KORS, TIF | 0 Comments

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Tiffany (NYSE: TIF) is an iconic American brand with 175 years of retailing success. The company has become a symbol of American artistry and quality that has successfully made the transition from an American to a global brand. For the past two quarters, Tiffany underperformed expectations, and as of the date of this article the stock is trading at or near its 52 week low. 

Current Situation

Tiffany released 1^st quarter results on May 24. The company reported that net sales increased by 8% from the same quarter in 2011 to $819 million. The company also reported that net earnings were lower than expected, up 1% year-over-year and resulting in a $0.64 diluted EPS; but, if one-time charges from 2011 were added back in, then net earnings actually fell by 5%. The decline is partially explained by poor performance in the North American region and strong sales growth from the same quarter in 2011. Since these announcements, Tiffany stock has declined over 18.5%. Interestingly, on May 17, only a week before the release of 1^st quarter results, Tiffany reported that it was increasing its quarterly dividend by 10%, from $0.29 per share to $0.32 per share.

Tiffany had announced earlier in 2011 that the ongoing economic turmoil in Europe was starting to affect sales in the European region. However, only about 15% of its revenue is generated in Europe. Additionally, potential investors should take into consideration that although 1^st quarter net earnings were weaker than expected, the company’s sales are highly seasonal, which is a common trait shared among retailers. Tiffany generates nearly 30% of its revenue in the 4^th quarter. The 4^th quarter also accounts for approximately one-half of the company’s annual net earnings. 

In the company’s 4^th quarter and year-end release, Tiffany's management gave their outlook for 2012, stating that they expected 10% annual growth, primarily driven by sales in the Americas and Asia Pacific, and that diluted EPS would grow 16-19% for the year. At first glance, 1^st quarter results did not support these estimates; however, the outlook stated that the majority of the earnings growth would occur in the later part of 2012. This indicates that investors are potentially overreacting to the 1^st quarter results and pushing the stock price down below what is merited.

Competition

Tiffany has few direct competitors in the luxury jewelry business, so for direct competition I also looked at other luxury goods companies. On April 24, Coach (NYSE: COH) reported a 17% growth in sales for the 3^rd quarter and earnings up 24%. These strong numbers were bolstered by new pricing and promotion strategies in the factory store business. Coach is also a luxury company that has a growing presence internationally. The company announced that it saw strong increases in China over the period, adding to the better-than-expected results, and that it took control of its domestic retailing business in Taiwan with plans to do the same in Malaysia and Korea. Coach management also announced that it would be increasing its dividend by 33%, to an annual rate of $1.20 per share.  

Michael Kors Holdings (NYSE: KORS) is another luxury retailer that went public in December 2011. On June 12, the company announced its 4^th quarter results, which were stronger than expected. Revenues increased 58.3% year-over-year for the 4^th quarter, while income grew to $0.21 per share from $0.10 the same quarter a year ago. Michael Kors saw comparative same store sales grow by 37.2% in the US and 13.6% in Europe. The company, like Coach and Tiffany, operates stores internationally, and has locations in the United States, Canada, Great Britain, France, Germany, Italy, Turkey, South Korea, Japan, and Hong Kong.

Blue Nile (NASDAQ: NILE) is an online diamond retailer that has been in business since 1999. The company sells certified diamonds, engagement rings and other fine jewelry. Blue Nile released 1^st quarter results on May 8, reporting that sales for the first quarter increased by 3.6% to $83.1 million. Of that net figure, nearly 56% came from the sale of engagement rings, which equaled $46.4 million. Net income was $154,000 for the quarter, or $0.01 per diluted share. Blue Nile said they expected to have EPS come in at $0.04 to $0.07, while analysts expected EPS to come in closer to $0.17. A penny in EPS made for a very unhappy Wall Street, and Blue Nile stock took a severe dip to $27.71 from a 52-week high of nearly $50. Blue Nile currently trades around $29.70, with a P/E ratio of 47.54. 

Valuation 

For a deeper dive into Tiffany’s financials, I looked at the company through a discounted cash flow model. This is where I discovered some potentially troubling information. Cash flows from operations from quarter to quarter were sometimes negative. Overall for the 2011 fiscal year, cash flows from operations were $210.6 million; however, the rolling 12 month cash flow as of 4/30/2012 was $134.3 million. As of 4/30/2012 Tiffany also had approximately $591.6 million of short and long term debt. 

Tiffany’s sales are generated primarily in its retail stores, which may see relatively heavy foot traffic as they are often considered tourist “destinations” in major cities. They cannot maintain these store operations without some investment back into their locations, so, assuming that investments remain relatively flat from year to year, I backed out leasehold and building improvements from my estimates. This leaves available cash flow within a range of -$.9 million to $75.3 million. 

There are several economic factors that may be causing the decline in free cash over the trailing 12 months, one of which is increasing commodity costs (gold, diamonds, and silver are all trading near their 6 year highs). Another is Tiffany’s aggressive expansion plan to open new stores every year. As the company opens new stores, they must also stock these stores with merchandise, hence inventory levels increase, investments in inventories go up, and free cash goes down. Using a conservative discounting such as the S&P 500 as a benchmark and assuming that the 2011 cash flows are a better predictor of future performance than the rolling 12 months, gives me a share value of $47.29. This falls well below my relative value estimates and may be an indicator that Tiffany’s earnings do not give us a clear picture into the operations of this company and that cash flow tells a deeper darker story.  

For a value investor, I would recommend waiting for the stock price to falls near the $47 share mark before taking a long position. Additionally, consider this: Once commodity prices start to decrease, Tiffany already has a stockpile of gold and silver purchased at higher prices. They will not be able to discount the price of these precious wares to meet new economic pricing realities without sacrificing margins to do so. 

Conclusion

Commodity costs have put a squeeze on jeweler margins. Blue Nile has taken the effects of increased commodity prices on the chin. Additionally, potential investors should continue to monitor the state of affairs in Europe for signs of a continued stalwart or for an eventual turnaround. Tiffany’s slower than expected sales are primarily a result of the global economy and the European debt crisis. In any case, I am taking a wait and see attitude with Tiffany as the stock may not have bottomed. The upcoming earnings release will tell us a story of improving cash flows or declining earnings. 

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