Tiffany's - Earnings Shine, The Valuation Appeal Does Not

 |  About: Tiffany & Co. (TIF)
by: The Value Investor


Tiffany delivered a big headline EPS beat over the past week.

At the same time, the company only increased its full-year guidance by a modest amount.

I fail to see appeal at current levels given that shares trade at a significant premium versus the market.

Investors in Tiffany & Co. (NYSE:TIF) initially reacted with great enthusiasm to the release of its second-quarter results with shares spiking on the back of the big beat on the reported earnings per share headline.

Enthusiasm faded a bit as the company only raised its outlook for the full year by five cents, after beating consensus estimates by ten cents. I must say that I am cautious as well, with shares trading at a premium valuation despite the solid track record of revenue growth and modest share repurchases. While these operational achievements are solid, I do not see much appeal with shares trading at a significant premium versus the overall market.

Second Quarter Highlights

Tiffany's posted a 7.2% jump in second-quarter revenues towards $992.9 million. Revenues came in just ahead of consensus estimates which stood at $989 million.

The company did a great job in showing real operating leverage on this sales growth, posting earnings of $124.1 million, which is a 16.2% increase compared to the year before.

Amidst a very tiny increase in the outstanding share base over the past year, earnings rose by thirteen cents to $0.96 per share. Earnings came in far ahead of consensus estimates at $0.86 per share.

Looking Into The Performance

The 7% revenue growth rate was healthy, with currency movements on a net basis having no effect. Overall comparable sales growth came in at 3% thanks to strength in North America and Asia-Pacific.

CEO Michael Kowalski was happy with the results stressing that performance among most of its product categories has been solid. Important as well, the company is upbeat about the Atlas collection as well as the new Tiffany T jewelry collection.

North American sales rose by 10% in constant currencies to $484 million which was supported by a very healthy 8% increase in comparable store sales. Asia-Pacific was a real bright spot as well with revenue growth of 13% in constant currencies resulting in sales of $237 million thanks to strength in China in particular.

Japanese sales fell by 10% in constant currencies to $119 million due to the effects from the hike in the consumption tax on April 1. Another disappointment was Europe, as sales grew by just 1% in constant currencies to $120 million.

Overall, the company did a great job in expanding its margins on the back of this sales growth. Gross margins rose by 240 basis points to 59.9% of sales thanks to favorable input pricing and higher prices. Higher operating expenses, which rose by 150 basis points to 38.9% of sales largely made the gross margin gains undone.

Updating The Full Year Outlook

Thanks to the solid results, Tiffany's now foresees full-year earnings coming in between $4.20 and $4.30 per share, a five cent hike compared to its previous outlook.

Underlying this earnings outlook is the expectation for worldwide sales to increase in the high single-digits. The company plans to open 10 company-operated stores while closing three existing ones. Operating margins for the entire year are seen higher as well, driven by the gross margin expansion in particular.

A Look At The Valuation

Tiffany's ended the year with cash holdings just slightly short of $400 million, as the company's debt load increased towards $1.03 billion. This results in a net debt position of about $630 million, an amount which is very much manageable for the firm. Also note that the business is quite capital intensive in terms of inventories which rose to 2.5 billion, tying up much capital in the process.

With 130 million shares outstanding at the end of the quarter on a diluted basis, the business is valued at $13.1 billion as shares trade just above the $100 mark. Given the outlook as given by the firm sales could come in as high as $4.4 billion as earnings are expected to come in around $550 million. This values the business at roughly 3 times sales and 23-24 times anticipated earnings.

Long-Term Growth, But What About The Earnings?

Tiffany's has demonstrated very steady growth in its sales over the past decade, essentially doubling its sales from $2.2 billion to $4.4 billion, growing sales at an average of 7-8% per annum.

Earnings have risen as well, but growth has been much more limited as margins have been under some pressure. Despite this, margins were still very impressive coming in at 12-13% after tax. The company did retire about 10-15% of its shares outstanding over this time period, adding to earnings per share. Share repurchases did cost the firm quite some money, resulting in a modest built up in net debt which is still very much manageable.

Back in May, I checked out the investment case for a potential investment in Tiffany's. I concluded that the luxury end of the market continues to move along just fine, while the cheaper Atlas collection has seen very impressive sales. This is amidst a difficult retail environment if you don't solely operate in the very high end of the market.

The long-term growth is steady, yet the current premium valuation of about 30-40% versus the wider market seems a bit stretched. This is as the company is slowly taking on some leverage to finance share repurchases. While the top-end of the market will most likely continue to do fine, with equity markets and other asset classes trading at fresh highs, I fail to see the triggers behind further share price appreciation.

As such, I continue to watch the action from the sidelines, as I fail to see real appeal in the risk-reward at current levels.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.