The received wisdom is that luxury goods companies underperform in an environment of tepid economic growth. That isn't the case for Tiffany & Co. (TIF). While the U.S. economy has been mired in a protracted period of sluggish economic growth in the five years since the financial crisis, Tiffany has actually seen its stock rise by 65%, aided by a 33% surge in the year-to-date.
Tiffany vs. S&P 500 and US GDP Growth
As the chart above illustrates, Tiffany's gain is nearly six-times the growth of the U.S. economy, as measured by its Gross Domestic Product, over the same period. It is also more than triple the return of the S&P 500 during this span and superior to that of the S&P Global Luxury Index, which added 58% during this time frame.
In short, the received wisdom doesn't pass muster: Luxury goods have done relatively well during a period of economic sluggishness.
The rich are different from you and I.
Part of this may be related to the price of gold, which has risen by close to 48% during this span. Interestingly, the rise in Tiffany's stock moved in relatively lock step with the price of gold for much of the past five years, only diverging when gold prices peaked in mid-2011.
That this is so should surprise no one since a key component of Tiffany's signature goods is the precious metal; the run-up in gold prices over the years has given Tiffany considerable pricing power. In fact, Tiffany's gross margins over the past five years have been a robust 61%, over 13 percentage points better than that of the S&P 500 and 10 percentage points higher than its peer group of luxury purveyors.
Another reason is the spectacular growth of emerging markets, whose aggregate GDP grew by an average of 5.6% over the past five years compared with just 0.5% for Advanced Economies, which bolstered luxury goods spending. Accessories, which are Tiffany's staple goods, recorded the best performance in the luxury sector during this period.
So, to amend our earlier assertion: the newly rich are different from you and I.
Does this mean that Tiffany will continue to outperform the market or is the stock exhausted after a strong five-year run? We take a look.
Tiffany's stock price has surged in 2013 largely as a consequence of the company beating expectations during its last reporting quarter, when it posted earnings of $1.40 per share - 4-cents better than the consensus. This result broke a streak of three consecutive quarters of earnings misses and precedes what is expected to be a down quarter for Tiffany. To wit, analysts expect Tiffany to report earnings of just 52-cents when it discloses its fiscal first quarter results on May 28th. That's a drop of close to 19% from the same quarter a year earlier even though revenues are expected to rise by 4.4%, suggesting margin compression and cost pressures.
Part of this may reflect short-term negativism over emerging market revenues as China experiences a bout of economic sluggishness. China, after all, is the engine that powers emerging markets, particularly those in Asia-Pacific, which was a strong region for Tiffany during its fiscal fourth quarter, growing by 13%. Indeed, Tiffany is expected to record full-year earnings growth of nearly 10% in its fiscal second quarter and by 7% for the full year.
What's more, Tiffany's earnings growth is expected to accelerate in fiscal 2014, growing by 14% and, for the next five years overall, its EPS should grow by 11.7% - faster than the 11.6% it recorded over the past five years. While that may not seem too impressive, it's worth noting that this is over 2 percentage points better than the expected growth rate of the S&P 500 during this span and is in-line with that of its industry.
Supporting this is expectations that GDP growth in developing Asia will accelerate over the next two years. Coupled with the ongoing recovery in the United States and the bottoming of the Eurozone economies, it seems more likely than not that Tiffany will be able to meet earnings expectations beyond its current quarter.
Fundamentals And Valuation
Tiffany is currently trading at a rich 23x earnings - a 20% premium to both its peer group and the S&P 500. Given its growth prospects, this might seem to be a fair premium considering that even with it, Tiffany's dividend yield of 1.8% is still better than the luxury sector's 1.6%. Having said that, Tiffany is clearly trading at levels anticipating a further improvement in its fundamentals.
This won't happen overnight but the potential is there. Notably, Tiffany has invested at a much faster rate (14%) than its rivals (4%) over the past five years - to be expected since it is clearly betting that expansion in emerging markets is necessary to solidify its future prospects and to wean itself away from too much dependency on richer developed markets. Investors shouldn't be wary, however: Tiffany's return on investment over the past five years has been at nearly 13%, about double the 6.7% rate of the rest of the luxury goods sector. What's more, those investments have likely not yet matured, meaning that there is further upside to Tiffany's already superior ROI.
Even better, Tiffany has the scope to make further investments or weather a downturn in its key markets. To wit, its healthy margins have enabled its cash ratios (quick and current) to rise above that of its peers while also allowing it to remain debt-light with less than 30-cents of debt for every dollar of equity - a ratio that is less than half that of the S&P. That means that Tiffany can leverage itself further if necessary to fund further expansion in emerging markets or reinvest in developed markets.
While we like Tiffany's growth prospects and admire the rigor with which management has ensured its sustained profitability, Tiffany's current valuation and the 30% run it's had in 2013 makes it difficult to recommend its stock outright. Indeed, at north of $76 per share, it is already 4% above its consensus one-year target price.
As such, our preference is to wait for a correction in order to take a position in the stock since doing so will mean more meaningful gains once the stock hits our two-year target price of $85 per share.