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Shares of Tiffany's (TIF) fell over 6% during Thursday's trading session. The specialty jeweler retailer reported its third quarter results before the market open.

Third Quarter Results

Tiffany's reported third quarter revenues of $852.7 million, up 4% on the year. Worldwide net sales rose 5% in constant currencies, while comparable store sales rose 1%. Revenues missed consensus estimates of $858.8 million.

Gross margins fell to 54.4%, down 350 basis points compared to the year before. High precious metal prices and diamond costs, and lower sales leverage negatively affected margins.

Net income fell 30% from $90 million last year to $63 million during the quarter. Diluted earnings per share fell from $0.70 to $0.49 per share. Earnings missed consensus estimates of $0.63 per share.

Tiffany's did not repurchase any shares during the third quarter. The company opened 12 new stores during the quarter, bringing the total number of operated stores to 272.

CEO and Chairman Michael J. Kowalski commented on the results, "Three months ago, we had anticipated that third quarter results would be affected by continued economic weakness in many markets as well as by challenging comparisons to last year when net sales were up 21% and net earnings had increased 52% excluding nonrecurring items."

Detailed Information

Sales in North America rose 3% to $400 million, driven by a 1% increase in comparable store sales. Sales in the important New York flagship store rose 5% during the quarter, despite being closed for two days. Internet and catalog sales rose 3% during the third quarter.

Asia-Pacific sales rose 2% to $188 million during the quarter. Comparable store sales fell 4% during the quarter, offset by higher prices.

Japanese sales came in practically unchanged at $147 million. A strong dollar impacted results. In constant currencies, sales rose 3% during the quarter, driven by a 5% increase in comparable store sales.

European sales fell 6% to 498 million, driven by a weaker Euro. In constant currencies, sales actually rose 11% during the quarter, driven by a 8% increase in comparable store sales.

Outlook

For the full year of its fiscal 2012, Tiffany's expect to earn between $409 and $435 million, with diluted earnings per share coming in between $3.20 and $3.40 per share. Previously, Tiffany's guided for full year earnings of $3.55-$3.70 per diluted share. The guidance is in line with analysts estimates of $3.59 per share.

Worldwide sales are expected to grow between 5 and 6%, down a percent point from the previous guidance.

The guidance implies that fourth quarter earnings are expected to come in between $172 and $198 million, or $1.70-$1.85 per share. This compares to last year's final quarter earnings of $178.4 million, or $1.39 per diluted share.

CEO Kowalski commented on the outlook, "We continue to maintain a cautious near-term outlook about global economic conditions. However, we expect to see improving results in this holiday seasons, partly benefiting from easing year-over-year sales comparisons."

Valuation

Tiffany's ended its third quarter with $345.9 million in cash and equivalents. The company operates with $977.9 million in short and long term debt, for a net debt position of $632 million.

For the first nine months of its fiscal 2012, Tiffany's generated total revenues of $2.6 billion. The company reported a net profit of $237 million, or $1.85 per diluted share. Full year revenues are expected to come in around $3.8 billion, with earnings coming in around $425 million, or $3.60 per diluted share.

Factoring in the share price decline on Thursday, the market values the firm at roughly $7.6 billion. This values Tiffany's at roughly 2.0 times annual revenues and 17-18 times annual earnings.

Tiffany's pays a quarterly dividend of $0.32 per share, for an annual dividend yield of 2.1%.

Some Historical Perspective

Year to date, shares of Tiffany's lost roughly 10% of their value. Shares started the year around $66 per share and rose to highs of $73 in March of the year. Shares fell to $50 in June after the company lowered its full year outlook, and have rebounded to $66 at the start of the month. Shares are currently exchanging hands at $60 per share.

Shares of Tiffany's rose from lows of $17 during the financial crisis in 2009, to an all time high of $82 in 2011. Shares lost roughly a third of their value on the back of disappointing results this year. Between 2008 and 2012, Tiffany's grew its annual revenue by approximately a third to $3.8 billion. Earnings rose from $220 million to an estimated $425 million this year.

Investment Thesis

Tiffany's shares are falling on Thursday, mostly as the result of the disappointing third quarter results. The full year earnings outlook, although lowered, is in line with analysts expectations.

Third quarter results were impacted by a range of headwinds. Year-on-year comparables were impacted by a strong third quarter last year. Hurricane Sandy made the company close some of its stores as well, including the New York flagship store which was closed for two days. A higher tax rate impacted earnings by $0.03 per share, while lower gross margins impacted earnings by $0.08 per share.

The outlook for the fourth quarter is a bit more optimistic as the negative impact of a strong dollar is moderating. Furthermore, gross margins will recover, but will still be below last year's levels. New store openings and new product lines will boost final quarter earnings as well.

Higher taxes and the impact of Sandy are clearly one-time items impacting results over the past quarter. The company sees a recovery in gross margins in the fourth quarter, but failed to quantify this outlook. The disappointing gross margins in the third quarter quite worrisome. Gold prices peaked in the third quarter of 2011 at record levels around $1900 per ounce and have fallen on a year-on-year basis.

Tiffany has a reasonably solid balance sheet and pays a fair dividend. Yet valuations are not compelling enough on earnings multiples given the continued margin pressure and the relative slow pace of same store sales growth.

In September, when Tiffany's reported its second quarter results I argued that shares were fairly valued. Today I reiterate my stance, I remain on the sidelines as there are no compelling short or long arguments.

Source: Tiffany & Co. - Disappointing Third Quarter Results Sends Shares Lower