I suspect that Tiffany (NYSE:TIF) is over-hyped as a bellwether for the consumer confidence of the well-to-do, but the reality is that it's still a large and well-followed retailer. To that end, the strong comp growth here this quarter was a welcome change of pace for what has been a relatively unimpressive run in retail.
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First Quarter Results Come In Strong
Tiffany certainly did better than Wall Street's sell-side expected this quarter. Even so, management kept a lid on guidance – likely a prudent move given a spate of disappointing recent guide-downs and uncertainties over product repositionings.
Revenue rose 9% as reported this quarter, or 13% on a constant currency basis. Comps rose 4%, or 8% in constant currency, with was more than double most sell-side estimates for the quarter. Constant currency comps growth was led by a very strong rebound in Japan (up 21%) and ongoing strength in Asia (up 9%). Curiously, Europe's comp growth (6%) was stronger than that of the Americas (up 3%).
Margin performance was a mixed bag – generally better than expected, but not exactly strong in its own right. Gross margin declined about a point from last year, but was stronger than expected by the Street (to the tune of a four-cent beat). Tiffany gave up some of this (about one cent) on SG&A, though, and operating income growth was limited to 5%.
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Continuing To Polish The Silver
Tiffany's silver business continues to be a tough one for management. On one hand, a prior assortment proved quite popular and beneficial for gross margin. On the other hand, it was popular with the wrong shoppers and analysts, investors, and apparently management feared that the company was risking its brand image with these more affordable (and profitable) items.
Given what has happened at Coach (NYSE:COH) and Nordstrom (NYSE:JWN), I suppose I understand the fear to a certain extent. It's a constant balancing act for companies like LVMH (OTC:LVMUY), Richemont, and Prada to both continue to grow the business (bringing in new shoppers or getting shoppers to come back and buy more) and preserve the exclusivity that serves as a primary appeal for the brand. If everybody can buy a Tiffany bauble, there's no exclusivity in it and, for many shoppers, no point.
To that end, management is looking to use innovation and marketing to grow the silver business, but do so in a way that doesn't compromise the cache of the brand. On a related note, the Great Gatsby collection and the reintroduction of the Atlas collection may both have a lot to do with whether the company can maintain its comp growth momentum for the balance of the year.
Will Less Precious Metal Enthusiasm Help The Business?
With the exception of the lower-priced silver items, Tiffany is pretty much a “cost plus” business where passing along the incremental increases in precious metal and gemstone prices isn't all that difficult. Still, that doesn't mean that turbulent precious metal markets don't add volatility to the reported results and increase inventory risk. While Tiffany can take a long-term view that “the commodity markets taketh … and the commodity markets giveth”, Wall Street is seldom so patient.
To that end, then, I wonder if the weakness in precious metals is a welcome development. Inventory growth was limited to 7% (constant currency) this period, but if gold and silver are now less appealing as speculative playthings for investors, I suspect that may work in the company's favor.
The Bottom Line
Because of the significant year to year changes in net working capital (particularly inventory), ordinary discounted cash flow analysis doesn't work especially well for Tiffany. Specifically, the company's returns are generally both quite low and very volatile. Strip away the net working capital and concentrate on the so-called “structural free cash flow”, though, and the results start looking more predictable and consistent. Structural free cash flow does lack some rigor (in particular, it just assumes that net working capital changes “work themselves out” and balance out to zero on a net present value basis), but it makes life easier for the analyst/investor.
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Assuming that Tiffany can maintain a low double-digit structural free cash flow margin while growing revenue at a mid-to-high single digit rate, fair value seems to be around $74. That doesn't leave the shares looking like much of a bargain here at $80, but Tiffany is a stock that seldom trades at a bargain (though brief 20-30% pullbacks to occur almost every year). What's more, as the owner of one of the strongest global brands, there's a wider moat here than is normally the case. I'm in no hurry to chase Tiffany near a 52-week high, but I'd certainly keep an eye out for the next 20-30% pullback as a buying opportunity.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.