Tough Q2 Comparisons Provide a Window to Invest
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Tiffany’s (NYSE: TIF) stock price has declined 7.5% since the company reduced its FY12 guidance on the 24th of May as compared to a 5% increase in the S&P 500 index and around a 5% decline in the luxury group. We believe this pullback has opened a window of opportunity into one of the best brands in luxury with significant global expansion opportunities.
The millionaire population worldwide is expected to grow 73% by 2020 and spending growth luxury consumption is expected to grow 7%-10% annually from 2011 to 2014. We are confident about Tiffany’s positioning and ability to capture the growing worldwide demographic of luxury consumers as the company is going strong with the second highest sales per square feet (~$30,000 sales per square feet) among all the retailers after Apple and the company also posted a 10.6% year over year increase in sales per square feet on top of a high-single digit square footage growth in FY11. The following are some other positives that make us bullish on the stock.
Tough comparisons in Q2 but easier Q4
Tiffany is facing the toughest year ago Same Store Sales comparisons in Q2 (28% SSS growth in 2Q11). The quarter likely got off to a slow start, as U.S. jewelery spending data suggested a soft May, following a 3.7% decline in April. Thus, we expect very low SSS (flat to low single-digits) in Q2. However, Q4 is likely to be a better quarter due to the easiest SSS comparison of the year at +6%. Also, Gold, platinum, and silver prices are down in double-digits from the YTD peak. So, going forward these declines in precious metals costs should begin to flow through and we will see gross margin expansion in Q4. We believe Q4 will very well make up for the lost sales/earnings in Q2 and the company will easily achieve FY12 EPS estimates of $3.67.
Increased Brand Awareness through Global Growth
We see numerous opportunities for Tiffany to expand internationally, with a primary emphasis on Asia-Pacific and the Middle East, notwithstanding opportunities in North and South America. Despite the current macro environment, Tiffany remains committed to grow in virtually all markets. The company is very particular about unit growth in China despite high import taxes. This has increased brand awareness among the Chinese and as a result the company will continue to see increased sales to Chinese tourists in European stores and the NY flagship store. Tiffany's is structuring a joint venture between Damas Jewelery LLC which will enable Tiffany to offer a wider range of styles and ranges to UAE consumers. Considering the extreme wealth in the region and Tiffany's weak exposure (Middle East contributes just 1% of total sales) with respect to other competitors, we believe there is an ample growth opportunity.
Potential for long term EPS growth
We believe that Tiffany can post 15%+ EPS growth over the long term, driven by mid-to-high single-digit growth in square footage and mid single-digit sales per feet growth driven primarily by leverage on costs, but also on gross margin.
The company has also made select investments in mining and exploration as part of its strategy. Tiffany’s efforts to step up control of its supply chain are not limited to diamonds. The company now manufactures roughly 60% of its products in 10 facilities, up from roughly 20% in the mid-1990s. We expect that number to climb up to 70% in the coming years. While several of Tiffany’s luxury competitors like Harry Winston (NYSE: HWD) and LVMH-owned Bulgari insist on owning all of their production, we like Tiffany’s mix, as it allows for a more flexible cost structure and provides some sourcing scale in an inflationary environment. The company is trading at a forward P/E of 13.59x which we find attractive. Thus, we recommend it a buy.
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