All but one of the 21 analysts who cover high-end jeweler, Tiffany & Co. (NYSE:TIF) are refusing to issue a "sell" rating on the stock.
Why should they do so? Because Tiffany has the fourth-highest sales exposure to Japan out of S&P 500 companies. And needless to say, the current crisis in the country promises to put a dent in consumer demand.
But analysts are curiously upbeat on Tiffany. On Thursday morning, Barclays told clients that, "Tiffany will rise to the challenge ... we continue to believe Tiffany has the pricing power and ability to navigate a challenging commodity environment to protect its gross margin rate.”
And over at Oppenheimer, analysts similarly downplayed any concerns, saying, "History offers clarity. The Kobe earthquake impact on TIF proved short-lived. TIF is now less dependent on Japan.”
Sorry, folks. Hope might be enough to win the White House but it isn’t enough to maintain the profitability of a company. And shrugging off the potential impact of Japan’s earthquake on Tiffany’s profitability is a big mistake.
Here’s why …
Little Country, Big Spenders
Although Japan is only about the size of Montana, its citizens are similar to China’s, in that they have a hankering for luxury goods. In fact, Japan accounts for as much as 23% of worldwide luxury goods sales, according to MF Global. And per capita spending on luxury goods in Japan is twice as high as the United States.
It’s no surprise then that Tiffany has such a large presence in the country. It operates 55 stores and derives 18.7% of its total sales from Japan, based on its results over the past nine months.
But the line Wall Street keeps feeding us is that such a level of sales exposure to Japan isn’t meaningful, nor a real threat. I’m not so easily convinced, so I dug into the company’s latest 10-Q filing.
Sure enough, Tiffany’s exposure to Japan is more significant. Over the past nine months, Japan accounted for 24.9% of Tiffany’s earnings from continuing operations.
And for a company that books about $265 million in annual profits, I’d say that a threat to 25% of those profits is something to be seriously concerned about.
If Tiffany endured a 20% decrease in sales in Japan, earnings from continuing operations could drop by 5% or $14 million. And such a sales hit is certainly possible.
After all, luxury goods sales in Japan dropped by 20% during the economic crisis of 2008. And that was without any retailers’ stores being closed.
During the earthquake/tsunami crisis, however, Tiffany has obviously had to close some of its stores, including one in the hardest hit Sendai region. And the longer the closings last, the bigger the impact on sales and profits. Moreover, even if Tiffany re-opens all its stores quickly, the Japanese won’t be in buying mood anytime soon.
Why? Two reasons …
1. Even before the earthquake hit, Japanese consumer demand was soft. Case in point: Over the past nine months, Tiffany’s comparable store sales in Japan dropped by 6%, on a constant exchange basis. Checking-up on another high-end retailer with significant Japan exposure confirms that weak demand isn’t just isolated to Tiffany… it’s widespread throughout Japan. In its latest 10-Q Filing, handbag maker Coach (NYSE:COH) said, "The current macroeconomic environment, while improving, continues to present a challenging retail market in which consumers, notably in North America and Japan, remain cautious."
2. A change in consumer behavior in the aftermath of the earthquake is imminent. Or as Lawrence Creature, fund manager at Federated investors puts it, "Even for Japanese consumers who have the means, they may not be in the mood to open up their wallets [as the nation rebuilds]." Heck, our own behavior in the United States underscores the inevitability of demand destruction in the wake of a crisis.
As the recession unfolded, consumers shunned high-end retailers like Nordstrom (NYSE:JWN) and Saks (NYSE:SKS) and instead flocked to deep discounters like Family Dollar Stores (NYSE:FDO) and Big Lots (NYSE:BIG). In turn, the share prices of the former plummeted, while the discount retailers’ prices soared.
It’s not a stretch to expect the same shift in consumer behavior to play out in Japan. And if you think I’m the only pessimist, think again. Tiffany spokesman Mark Aaron said, "The situation [in Japan] is fluid."
High-End Goods … and a High-End Share Price
Given the choice of taking cues from company insiders or Wall Street analysts, it’s a no-brainer. I’m siding with insiders.
And their take isn’t exactly instilling much confidence in me with Tiffany.
I can’t even justify buying Tiffany on a valuation basis. At current prices, it trades at a 37% premium to the average stock in the S&P 500, based on its price-to-earnings ratio. And even on a forward price-to-earnings ratio it’s expensive, trading at a 22% premium.
With the company set to report its fourth quarter results before the market opens on Monday, shares promise to be extra volatile in the days ahead. I expect managment to provide a less than inspiring update on Japan operations.
So don’t listen to Wall Street – this is one stock you should sell before the total impact of the Japan crisis is realized.