Aspirational retailer Tiffany (TIF) announced better-than-expected results for the first quarter of fiscal year 2014 Tuesday morning. Global sales increased 9% year-over-year (13% ex-currency) to $895 million, exceeding consensus estimates. Earnings per share were also better than anticipated after Tiffany tempered first quarter expectations, as earnings were 10% higher year-over-year at $0.70 per share on a non-GAAP basis. While the firm didn't give out free cash flow during the quarter, it did give full-year free cash flow guidance of $300 million.
The company's previous fears of margin deterioration did come true as gross margins declined 110 basis points year-over-year to 56.2%. Management cited product mix as the major driver behind the weakness as consumers shifted toward purchasing higher cost items, consistent with the firm's retailing strategy. Over the long term, this should help cement Tiffany as a luxury brand in the eye of consumers, but we also think it will boost the company's appeal as a takeover target. Richemont's chairman and largest shareholder, Johann Rupert, recently remarked that he didn't see Tiffany as a competitor due to its lower price point. Perhaps Tiffany's focus on the higher end is to not only win a more resilient customer, but also to make the company more attractive to a higher buyer like Richemont, Louis Vuitton Moet Hennessey, or Gucci's parent, PPR.
On a geographic basis, the big surprise came out of Japan, where the company achieved robust same-store sales growth of 21% ex-currency year-over-year, leading to revenue of $145 million. Because the yen depreciated so meaningfully against the dollar, this only resulted in a reported sales growth rate of 2%. Seeing such astonishing growth in a region that has been all but written off in recent years obviously warrants further investigation. Management provided some commentary, saying:
"It's worth noting that we took a price increase in Japan on April 10, which, beyond addressing product cost pressures, also included an adjustment for the yen's weakness. Based on the customary pre-announcement of a price increase in Japan, it spurred purchasing in advance of the increase. However, we did not experience the typical unexpected slowdown after that. So while we believe a portion of the first quarter sales growth certainly reflects the strength of our brand, we also attribute the unusual strength to recent reports of a surge in household spending in Japan, likely tied to the Japanese government's efforts to stimulate their economy. The store count remained at 55 in Japan at the end of the quarter."
Considering the buyers of Tiffany products are likely to be stockholders, the 37% year-to-date increase in the value of the Nikkei could be the cause of the strength. If such results continue, it could mark a turning point in the multi-decade malaise of the Japanese economy. We'll be watching this closely.
Results from Asia-Pacific were also superb, with reported sales 15% higher than a year ago (14% higher ex-currency) at $223 million. Same-store sales grew 9% year-over-year during the quarter, and management specifically singled out China as the growth driver. Although Tiffany isn't the most discreet luxury brand, many of its jewelry products do not contain excessive branding, which we believe is falling out of favor with Chinese consumers. We've heard such sentiment echoed from Richemont; and the possibility of new luxury taxes on conspicuous items could reinforce the trend towards more subtle luxury.
Sales in the Americas region, still Tiffany's largest, were fairly lackluster, growing only 6% year-over-year to $408 million. Same-store sales growth was relatively weak at 3%, though the company noted better than anticipated sales at the New York flagship driven by the company's Blue Book event. Not surprisingly, management noted that the US was mostly resilient, though tourist dollars in Hawaii and Guam were soft. On the other hand, Latin America's sales were equal to the year prior, reflecting the difficult environment in the region. We're worried that this could impact several other retail names like Nike (NKE) that have been counting on Latin America to drive growth. Currency issues, inflation, and leadership changes in several countries have been headwinds lately, but we think such issues should matter less in the long run.
Even with milder expectations from the Americas segment, the company did not alter its guidance for fiscal year 2014, reiterating its earnings per share guidance of $3.43-$3.53. Undoubtedly, we liked to see acceleration in Japan and solid performance from China, but this quarter does not change our long-term view of the company. Shares currently trade above the high end of our fair value range ($78), but we do not think shares are mispriced enough to warrant establishing a put in the portfolio of our Best Ideas Newsletter.