Highlights from Tiffany’s Third Quarter

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TIFFANY REPORTS SOLID THIRD QUARTER RESULTS

Key Takeaways from Tiffany’s Third-Quarter Results

  • Tiffany (TIF) is executing fantastically, and the Americas region, where comps jumped 11% in the quarter, was the standout. We expect the US to be the bright spot in the global economy for the holiday season across the luxury goods space. The US consumer is relatively healthy (the preliminary reading for GDP in the third quarter, released today, was 3.9%, a very healthy pace). 

  • Tiffany has become a gross margin story. The firm’s gross margin increased 250 basis points in the third quarter thanks to strong pricing, better cost controls, and a mix shift to higher-margin fashion jewelry.

  • We expect sales and margin strength to continue into the fourth quarter, holiday season, and into 2015 thanks to the TIFFANY T launch and the company’s Atlas collection.

  • Management maintained its adjusted earnings per share outlook for 2014 of $4.20-$4.30 per share, but it has raised this range twice already this year. The company is trading at 25 times this year’s earnings, which we view as pricey.

  • We think there will be a better time to initiate a position in Tiffany. We continue to believe shares are worth $85 each, which reflects an adjusted earnings multiple of 20 times this year’s earnings. Our fair value estimate assumes strong sales and margin improvement in coming years and is derived via a discounted cash-flow process.

Our Overall Thoughts on the Luxury Space

  • Luxury goods firms differentiate themselves based on brand name, perception, and quality in order to generate excess returns on invested capital through the economic cycle.

  • Building a large, successful luxury brand is difficult, leaving those that possess them with intangible competitive advantages that are not easily overcome by new entrants.

  • Growth in emerging middle classes and China will be the key demand drivers going forward, though the strongest brands will also grow successfully via market share gains. Though changes in consumer preferences should be watched closely, we like the structure of the group.

  • Michael Kors (KORS), by far, is showing the greatest traction of any firm in the broader luxury space. Same-store sales advanced an impressive 16%+ in its third quarter. Kors’ European same-store sales increased 41%, which is excellent by any measure. Michael Kors’ management points to its “fashion leadership and jet-set luxury experience.” Kors continues to see strong performance with accessories (primarily handbags and leather goods, the biggest gainers).

  • Our favorite value and income idea in the luxury space continues to be Coach (COH). The company has a near-4% dividend yield, and we think the payout is safe. We expect the firm’s comps to get better as it gets its North American handbag business on track. Coach’s performance in Europe and China were strong, but if management can right operations in North America, we could see 35% upside to its current stock price.

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Tiffany’s Third-Quarter Overview

  • Worldwide net sales increased 5% over the prior year, a 7% increase on a constant-exchange rate basis.

  • Growth in all regions except Japan, with largest growth in the fashion jewelry category, where comparable sales advanced 4%.

  • Net earnings, excluding charges related to the extinguishment of debt, rose 5%.

  • Earnings guidance for the current fiscal year maintained.

  • Encouraging performance from the recent launch of TIFFANY T jewelry collection, which targets the style-conscious female self-purchase customer with wide ranging and global appeal.

    • “TIFFANY T is offered in a range of materials with the majority of designs in yellow, white or rose gold, with and without diamonds, as well as some pieces in sterling silver, making the collection available in a wide range of prices from a few hundred dollars up to about $20,000. For the T collection, as well as our successful Atlas collection launched over the past year, it’s worth noting that gold jewelry is performing especially well.” – conference call

  • Continuing to pursue opportunities in marketing, merchandising, and store expansion to support longer-term growth.

The Americas

  • Total sales increased 10% in the third quarter and 9% year-to-date, respectively.

  • On a constant-currency basis, total sales increased 11% and 10% in the third quarter and year-to-date, respectively.

  • Comparable store-sales rose 11% and 9%, in the third quarter and year-to-date, respectively.

Asia & Japan

  • Total Asia-Pacific sales rose 2% in the third quarter, a slowdown from the 11% year-to-date pace. The pace of growth was the same on a constant-currency basis. There was “noteworthy” growth in mainland China.

  • Comparable store-sales in the Asia-Pacific region declined 3% in the quarter, but this was a result of more difficult comps in the prior-year period.

  • Total sales in Japan declined 12% in the third quarter, or a 5% decline on a constant-currency exchange rate.

  • Comparable store sales on a constant-currency basis declined 6% in the quarter and rose 4% in the year-to-date.

  • The soft demand in Japan is attributable to weaker economic conditions following an increase in consumer spending before the increase in Japan’s consumption tax on April 1.

Europe

  • Total sales rose 9% in the third quarter and 9% year-to-date, respectively.

  • On a constant-currency basis, total sales rose 10% and 5% in the quarter and year-to-date, respectively.

  • Comparable store sales increased 2% in the quarter due to strength in continental Europe, and declined 3% in the year-to-date period.

Profit margins

  • Gross margin rose to 59.5% in the third quarter and 59.2% in the year-to-date, from 57% and 56.9% in the respective prior-year periods.

  • The increases were driven by favorable product costs and price increases taken across all product categories and regions. A shift in product sales mix toward the higher-margin fashion jewelry category also aided gross margin performance.

  • The operating margin was 17.6% in the third quarter and 19.8% in the year-to-date, compared with 16.9% and 17.3%, respectively, in the prior-year periods.

Outlook for 2014

  • Maintaining its previous guidance that calls for net earnings in a range of $4.20-$4.30 per share.

  • Worldwide net sales increasing at mid-to-high single digits

  • Open 10 new stores, close 2

  • Higher operating margin thanks to gross margin increase

  • Free cash flow of at least $400 million

Capital Allocation

  • In March 2014, the company’s board authorized a new program to repurchase up to $300 million of the company’s stock over a three-year period. At October end, $278 million remains.