Proposing A Short On Tiffany's

Mar.13.13 | About: Tiffany & (TIF)

From experience, I know few things make a significant other happier than receiving a present encompassed in the iconic blue box from Tiffany's. If that recipient were also a current shareholder, there would be additional reasons to celebrate this year with shares up over 19% year to date. The shares have resiliently shrugged off the numerous negative earnings revisions from management, lackluster holiday sales and tepid global recovery.

As I alluded to in my previous short thesis for Dillard's (NYSE:DDS), I'm anticipating economic uncertainty, political gridlock, and increased taxes to weigh on consumer discretionary spending in 2013. Listening to Tiffany's third-quarter conference call definitely reinforced that suspicion. On the call, the CFO credited the year-over-year increase in sales to increased prices, not increased volume of customers. After missing profit expectations, the CFO apologetically made it clear that the mid-market jewelry customer is an import piece of its profit mix. Even though TIF is a high-end retailer whose brand is synonymous with wealth, the CFO referenced an unanticipated slowdown in its silver metal jewelry sales, which is a higher margin product targeted toward lower-spending clientele (such as myself). Surprisingly, shares have appreciated 16% since the disappointing holiday sales release on January 10, thus prompting analysts at Canaccord Genuity to cut their ratings on Tiffany's from "hold" to "sell," with an updated price target of $52.00 a share. Fundamentally, Tiffany's looks expensive relative to the peer group in earnings, cash flow, and sales multiples and it is underperforming on both profit metrics and growth in sales. Additionally, it is trading higher than its five-year average P/E of 17.9:

Metric

TIF

TIF Peers

Industry Average

P/E

21.7

18.8

16.2

P/Sales

2.4

1.2

0.6

P/Cash Flow

15.4

12.7

9.3

Return on Assets

9.94%

18.88%

11.65%

Return on Equity

17.41%

43.14%

20.44%

Return on Investments

11.45%

31.90%

12.13%

Sales Growth (5yr)

7.30%

8.54%

8.12%

EPS (Year over Year)

-5.39%

56.10%

3.89%

Click to enlarge

Given the firm generates over half its sales overseas, softness in American consumer spending isn't the only economic headwind Tiffany's is facing. As indicated in the chart below, Tiffany's generates 22% of its sales and 25% of earnings from the Asia-Pacific region, primarily from China, were it operates 22 stores. Below is a percentage breakdown by geography of Tiffany sales and earnings through the first three quarters of 2012:

3 months Ending Oct. 2012

9 months ending Oct. 2012

(in thousands)

Net sales:

Americas

400013

47%

1219776

48%

Asia-Pacific

187685

22%

556893

22%

Japan

146723

17%

447175

17%

Europe

97644

11%

285765

11%

Total reportable segments

832165

2509609

Other

20576

2%

48871

2%

Total

852741

2558480

Earnings

Americas

51890

35%

191697

38%

Asia-Pacific

36589

25%

122675

25%

Japan

42732

29%

135558

27%

Europe

16119

11%

53371

10%

Total reportable segments

147330

503301

Other

586

0%

Total

147916

499948

Click to enlarge

With China's economy cooling to an anticipated 7.5% growth this year, the new Chinese Premier has preached the old Communist principle of wealth redistribution, which is a far cry from promoting a culture that encourages vanity, much less high-end jewelry. Somewhat alarmingly for Chinese luxury brands, The Peoples Republic has recently undertaken a "Curb Extravagance" campaign, which initially targeted government opulence amid the recent publicity surrounding corruption and the abuse of public finances. However, this frugality movement has already gained popularity and has shown signs of trickling into consumer spending habits in areas such as high-end dining and five-star hotels. It remains to be seen if the temporary shift in lifestyle choices will affect other luxury brands such as Tiffany's.

From a technical perspective, Tiffany's is facing upward resistance in the $70-$75 area. While the upward channel certainly indicates a bullish trend, the chart below displays a compelling and defined area to trade against on the short side. Unfortunately, I'm not alone in thinking Tiffany's represents a unique short opportunity at current levels. According the Financial Times, short selling against Tiffany's is at two-year highs, rising over 10% in the last week. Currently, 11.6 million shares are being shorted, representing 9.48% of float. With spiking levels of short interest, investors on the short side should certainly be wary of being squeezed if Tiffany's surprises to the upside on the March 22 earnings call.

Click to enlarge

Diamonds may be forever but cash is still king. Below is a free cash flow to equity analysis of Tiffany's in the Gordon Growth model:

Current Earnings per share =

$3.24

-(1- Desired debt fraction) *

71.00%

(Capital Spending - Depreciation)

$4.34

$3.08

-(1- Desired debt fraction) *

67.00%

∂ Working Capital

($3.31)

($2.22)

Free Cashflow to Equity =

$2.38

Cost of Equity =

0.11713

Expected Growth rate =

4.00%

Gordon Growth Model Value =

$32.04

Click to enlarge

Due to the sensitivities of the model, I've included the intrinsic price per share based on various growth rates:

Growth rate

Value

8.00%

$69.11

7.00%

$53.94

6.00%

$44.08

5.00%

$37.16

4.00%

$32.04

3.00%

$28.09

2.00%

$24.95

1.00%

$22.40

0.00%

$20.29

Click to enlarge

Tiffany's closed Tuesday at $68.46

Conclusion

Even though my girlfriend loves receiving those blue boxes from time to time, I feel Tiffany's presents a compelling short opportunity at current levels given its relative valuation, technical landscape, and a potential further softening in global consumer demand.

Disclosure: I am short TIF, DDS, CCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long AAPL