Last week I slapped a “Sell” rating on Tiffany & Co. (TIF). Despite Wall Street’s love for the stock, I was convinced the company’s sales exposure in Japan would prove more troubling than most investors anticipated.
And I was right.
In this morning’s earnings announcement, chief executive officer, Michael J. Kowalski said, “In preparing our financial expectations for 2011, we have assumed some continued periodic store closings or limited store hours in Japan through the end of the first quarter … with total Japan sales declining 15%.” As a result, management reduced overall earnings expectations by $0.05 or about 8%.
Of course, these numbers represent management’s best estimates. Treat them accordingly. Truth is, there’s a strong possibility Tiffany’s overall sales and profit decline could end up being much worse. After all, Tiffany stores that generate more than 50% of Japan sales are still closed or operating on reduced hours.
The Great Unknown: Consumer Demand
As Frederic Bastiat pointed out over a century ago, “The good economist takes into account both the effect that can be seen and those effects that cannot be seen.” While Tiffany seems to have a handle on the immediate effects of the crisis in Japan, the company’s extremely vulnerable to “those effects that cannot be seen" -- specifically, the unknown psychological effects on Japanese consumers.
Keep in mind, it’s only been 10 days since the earthquake and tsunami hit Japan. To assume the Japanese consumer is going to spring back to buying anytime in the near future is foolish and arrogant.
As I said last week:
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 (JWN) and Saks (SKS) and instead flocked to deep discounters like Family Dollar Stores (FDO) and Big Lots (BIG). In turn, the share prices of the former plummeted, while the discount retailers’ prices soared.
And I’m convinced the demand destruction in Japan promises to be even more severe for one simple reason: Unlike the financial crisis, this crisis involves significant loss of life. When you’re mourning the loss of loved ones, the last thing you do is go buy expensive jewelry.
Or, more simply put, Tiffany’s stores might be open for business -- but there might not be any business.
Lackluster Growth and a Rich Valuation
Even if I’m completely wrong about the lingering impact on consumer behavior, Tiffany’s Japan operations aren’t exactly a bastion of strength. Consider the latest results:
[Click to enlarge]
While fourth-quarter and year-to-date sales jumped by double-digit margins in the Americas, Asia-Pacific and Europe, Japan lagged well behind. On a constant exchange rate basis, Japan sales only mustered a 2% increase for the quarter and actually declined 1% year-to-date.
Unless you like putting hard earned capital at undue risk, steer clear of Tiffany. Any short-term bounce in share prices is likely to be just that … short-term. Over the longer term, Japan operations promise to weigh on results for at least the next quarter. If any slowdowns in global consumer spending materialize, Tiffany’s earnings could suffer a big hit.
And given the stock’s current valuation, there’s little room for error. Based on price-to-earnings ratios, shares trade at almost a 40% premium to the average stock in the S&P 500.
While Wall Street – and women the world over – remain enamored with Tiffany's little blue box, we have no problem maintaining our “Sell” rating on the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.