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Tiffany – Profits By The Yard

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By: Nancy Kross
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Tiffany & Co. (TIF) is an international jewelry retailer that deals mainly in branded jewelry, but also sells diamonds and luxury goods like timepieces, china, crystal, stationery, fragrances as well as leather and silver goods. The company generates almost 90% of its revenues from jewelry sales and 8% from watches, leather goods, fragrances, stationery and other accessories.

Tiffany has a strong presence in the Americas, Asia-Pacific and Europe. The US is the most important region for the luxury goods retailer, with 115 out of its 275 stores located in the country. US stores contributed 48%, and its flagship store in New York alone contributed 8% to its net worldwide sales in 2012.

Since 2007, however, the US market has slowed down for Tiffany as growth rate has fallen below 1%. Meanwhile, Asia-Pacific and Europe are growing geographical regions in terms of revenue, with historic five-year Compound Annual Growth Rates (CAGR) of 11% and 12% respectively.

Industry Analysis

The jewelry industry, which is estimated to be worth more than $200 billion1, seems more susceptible to the ups and downs of the economy than other industries. However, since the industry is driven largely by demand from high net-worth individuals (HNWI), economic slowdowns do not affect the industry as acutely as they affect other industries.

The main drivers of the jewelry industry include GDP growth, the growing number of wealthy individuals, e-commerce sales and tourism.

The details regarding these drivers and the impact of recession on the jewelry industry have been provided in Bidness Etc’s previous analysis of the jewelry industry.

1 source: Tochtermann, Director of McKinsey and Company’s Apparel, Fashion & Luxury Group

Business Cycle

Tiffany experiences high seasonal fluctuations in sales. The company generates a third of its total annual sales during the fourth quarter (4Q) of the year.

Sales are higher during the fourth quarter because a number of social, religious and cultural festivals fall during the period boosting the sales of jewelry, leather goods, fragrances and other items. A look at the seasonality in Tiffany’s sales shows clear spikes in 4Q.

Financial Performance

Tiffany has so far performed better than its competitors by showing 5-year revenue CAGR of 5.2% revenue growth. Though there was only little dip of 3% in the revenue during the recessionary period, Tiffany quickly overcame the decline.

Here’s an overview of how Tiffany has performed in comparison to its competitors, Signet Jewelers Limited (SIG), Zale Corporation (ZLC) and Blue Nile Inc. (NILE).

Tiffany’s earnings have shown consistent growth, and its three-year earnings CAGR of 15% is better than that of two of its competitors, Zale and Blue Nile, whose earnings have fallen during the same period. It has however failed to match the 32% CAGR achieved by Signet.

Tiffany also has the highest gross margin compared to its three main competitors, which is attributable to its focus on cost efficiency.

Tiffany’s stock has outperformed the Dow Jones Luxury Index (DJLUX) by 33% year-to-date (YTD).

Even though Tiffany’s stock has performed well, it has failed to match Zale’s stock performance over the same period. Zale has introduced company-wide changes in its product line, changed its financing structure, and has increased investments in its sales staff.These measures have led to a 283% YTD increase in Zale’s stock price. However, it should be kept in mind that Zale’s price had fallen to $1 in 2009 on bankruptcy woes and this surge represents the rebound from those lows.

Upcoming Catalysts

Expansion in Global Distribution:

The company employs a multi-geographical distribution strategy, and intends to expand its reach by adding new stores in both existing and emerging markets. Tiffany already operates in 22 countries, and is now planning to enter the Russian market by opening its first outlet in Moscow. Analysts estimate the number of stores to reach 289 by 2014 as the management has announced plans to add 14 more stores this year.

E-Commerce Sales:

E-commerce operations in 13 countries drive 6% of Tiffany’s net sales and the rising popularity of internet shopping is good for the company’s growth prospects. The US e-commerce retail market is expected to grow at a CAGR of 12.82% over 2012-2016 as estimated by Technavio. Tiffany’s e-commerce sales have grown at a CAGR of 11% over the past three years and are expected to rise further as customers increase purchasing activity on the internet.

Increasing Demand for Luxury Goods:

According to a report by Research & Markets published in September 2013, the global personal luxury goods market is expected to grow at a CAGR of 7.9% up to 2016. The demand for luxury goods is rising with the growth in the number of HNWI (as indicated in a recent World Wealth Report), which has grown by 9.2% in 2012 (YoY), and is projected to grow by 6.5% annually over the next three years.

Emerging Markets:

Although North America has historically contributed the most to Tiffany’s sales, the Asia-Pacific region – specifically China – is emerging as the most promising growth market for the company. In the past five years, the Asia-Pacific region has experienced 11% revenue growth.

Potential Risks

Dependence on High Income Consumers:

Tiffany’s dependence on the high income group for sales growth can prove to be a double-edged sword. The demand for its products, which is moderately affected by economic downturns, can fall drastically if the company’s impulsive consumers lose interest in the brand.

Tiffany maintains the desirability factor for its products by sustaining its brand image, offering exquisite products, and delivering first-class customer service. The company also actively hunts for counterfeits of its products in order to safeguard its image as a premium brand.

Fluctuation in Precious Metal and Diamond Prices:

The prices of diamonds and precious metals such as gold, silver and platinum are the company’s main cost drivers and margins can shrink significantly if the prices of metals and diamond rise beyond a certain threshold. Last year, the company reported a two percentage points decline in gross margins over the preceding year due to higher costs of precious metals and diamonds.

Exchange Rate Fluctuations:

Tiffany may be a US registered company but operates globally. Therefore, the devaluation of other currencies against the dollar suppresses its reported profits. The impact of currency fluctuations is visible in Tiffany’s second quarter results FY14, during which net sales grew 4% according to the earnings statement, but if calculated on a constant-exchange rate basis, actually grew 8%.

Earnings Review (2QFY14)

Tiffany beat company and analyst earnings estimates by 12.77% with a 16% increase in net earnings during 2QFY13. Its higher-than-expected EPS of $0.83 was because of an improvement in gross margins from 56.3% in 2QFY13 to 57.5% in 2QFY14. Moreover, net sales increased 4%, with most of the growth coming from the Asia-Pacific region. The company raised its EPS guidance to $3.5-$3.6 for FY14 based on the following assumptions:

  • Increasing worldwide net sales by mid-single-digit percentages
  • Increase in operating earnings.

Valuation Matrix

The valuation matrix shows prices for Tiffany’s stock at different forward one year P/E multiples and EPS estimates.

Sell Side Expectations

The sell side has already revised Tiffany’s expected EPS upwards during the past four weeks. The average consensus for FY14 EPS is $ 3.61, with estimates ranging between $3.54 and $3.66. Based on this range, its stock price targets are as follows:

Barclays is bullish on Tiffany because of its geographical diversification and expected store expansion in 2013. It has set a price target of $100, which is 11.1% higher than its previous estimate of $90. Barclays’ target price has been calculated based on a P/E of 24.3x and an estimated EPS of $4.10.

Investment Analysis

The number of Tiffany outlets has been increasing at a CAGR of 8.4% over the past five years, and its revenues are expected to grow as a result. Each store contributes nearly $13.8 million to the company’s revenues every year on average, and Tiffany can add an estimated $193.2 million to its revenue this year after its 14 planned stores are opened.

Tiffany is expanding rapidly in the growing jewelry market in the Asia-Pacific region. Since 2007, Tiffany has added six stores to this region, and it plans to open seven more in 2013. The Asia-Pacific region holds significant growth potential since China and India are the biggest consumers of jewelry worldwide. As the number of wealthy households in China and India grows, we expect Tiffany’s revenues from this region to grow as well.

As far as brand loyalty goes, Tiffany has done a great job. Female American customers with an annual income of at least $200,000 rank Tiffany highest on their list of most frequently purchased brands over the past five years2. Given the increasing popularity of Tiffany among high income groups, we expect its revenues to grow in the future.

2(Source: Survey Results by The Luxury Institute)

Conclusion

Tiffany is a market leader in the jewelry industry because of its emphasis on global expansion, continued expansion in number of stores, and maintenance of an attractive brand value. Its revenues have grown at a five-year CAGR of 5.2%, higher than its competitors, and are expected to grow 5.8% by FY14.

Tiffany is a safe play for investors looking for consistent revenue growth. The revenue share from Asia-Pacific region has grown by 9 percentage points since 2007, and we expect the share to grow further due to increasing number of high income households in the Asia-Pacific region, especially China.  We feel the company can add value to an investor’s portfolio, and its stock is a buy.

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