In many sectors, stocks trade together, rising and falling based on what happens to one specific company in the industry. And the luxury goods sector is a good example of this trend. As consumer facing industries, luxury companies are, in general, linked together. But this is not always the case. The luxury market has many nuances, nuances that investors often miss and/or misinterpret. And as of this writing, one of those misinterpretations is on full display.
Burberry, the British luxury goods company, cutting low-priced goods on September 11 that full-year profit will fail to meet expectations due to a sales slowdown across the globe. Burberry's executives said the slowdown was broad-based, and that the company was not alone in dealing with challenging economic conditions. These comments caused Burberry to shed around a fifth of its value, its steepest plunge ever, and send ripples throughout the entire luxury sector, with Ralph Lauren (RL), Coach (COH), and Michael Kors (KORS) all dropping more than 1%. There is one company, however, that we feel has been unduly punished in this sector-wide selloff, one that is positioned differently than either Burberry or its peers. And that company is Tiffany's (TIF). In our view, Tiffany's is being unfairly punished for Burberry's sins, and we think that Tuesday's mini-selloff in the stock presents a good buying opportunity for long-term investors. We believe that Burberry's issues do not translate to Tiffany's, and detail our thesis below. We will focus on 2 key aspects: the brand positions of Tiffany's and Burberry, and the results of other luxury goods companies.
Burberry & Luxury Retail: Branding is Key
Luxury retail is not about selling people a product. It is about selling people an experience. If you are a retailer trying to sell something at a premium price, you must ensure that you are providing your customers with more than a simple purse, or pair of shoes, or coat. You must provide them with an experience, and make them feel happy for handing over hundreds or thousands of units of currency (dollars, euro, pounds, etc...) for a product that cost far less to make.
Luxury companies, be they in the clothing or automotive businesses, need to manage their brands carefully to ensure that they remain status symbols. There is a reason that Ferrari limits the number of cars it sells each year. If too many people drive one, there is no point in buying one. After all, people buy a Toyota (TM) to have something to drive. You buy a Ferrari to show the world that you can. Luxury retail follows the same principle: the market position of a brand is a company's most important asset. At the same time, luxury goods companies cannot price their products at irrational levels. There needs to be a balance between brand cachet and brand access, something that Burberry seems to have forgotten. In recent months, the company has been pruning its product lines, cutting low-priced goods, especially in the United States, in an effort to move up in the marketplace and make Burberry a more "elite" brand. We believe that this move has backfired. Instead of abandoning Burberry, customers who no longer wanted to buy its higher-priced goods could have traded down within the company's product lines. Instead, they simply looked elsewhere. Preserving the status of the brand is essential for a luxury company such as Burberry, but we believe that in this instance, things were taken too far. Burberry left too many sales on the table in its quest to move up in the marketplace. Tiffany's on the other hand, faces no such issues.
Remember, Audrey Hepburn Had Breakfast at Tiffany's, Not Zales or Signet
Tiffany's, founded in 1837, is synonymous with luxury jewelry, and though the company does have rivals in the jewelry business, such as Zales (ZLC) (founded in 1924) and Signet (SIG) (founded in 1949), we do not think that any company can come close to matching the cachet or perception of Tiffany's brand. While the Burberry brand does have cachet in the luxury clothing & accessories market, it fails to come close to the level of cachet that Tiffany's has in the jewelry market.
Given that luxury retail is about status and the experience of buying a product, Tiffany's has intrinsic advantages relative to its peers. The mere fact that a piece of jewelry was bought at Tiffany's can (and often does) make it more valuable to whoever buys it, even if a similar piece can be bought elsewhere for less. Consumers understand the intrinsic value of giving and receiving jewelry in a Tiffany's box, and such tastes have been ingrained in American, as well as international culture, for decades. After all, Audrey Hepburn had breakfast at Tiffany's, not Zales or Signet. Since its founding, Tiffany's has built a wide moat around its brand and stores, one that is not easily broken. Because the cost of Tiffany's products often runs into the hundreds of thousands, or even millions, service and quality become even more essential. And no jewelry company provides more quality or service better than Tiffany's.
What Are Other Luxury Companies Saying?
Burberry, in reducing its forecasts for 2012, said that it is not the only luxury company facing issues when it comes to the global macroeconomic picture. And yet, this contrasts with what several other luxury goods companies have been saying. Several have reported their quarterly and/or first-half results in the past few weeks, and they have provided generally upbeat assessments about the state of business and the months ahead. We break down several of these results below.
- LVMH: The world's largest luxury goods company stated that its earnings at the end of July, and was upbeat about the second half of 2012. CEO Bernard Arnault stated that LVMH plans to "pursue further market share gains in our historical markets as well as in high potential emerging markets." First-half profits grew by 28%, as sales rose by 26%. While organic revenue growth at the leather goods & fashion division (which houses the Louis Vuitton brand) came in at 10% for Q2, down from 12% in Q1, LVMH stated that it was confident in its prospects for the second-half.
- Richemont: The Swiss luxury goods holding company (which owns brands such as Cartier) reiterated revenue growth of 23% in the 5 months ended August 31 on the back of strong European sales (it is in fact possible to grow sales in Europe, if your customer base does not care that much about macroeconomic issues). Growth in Europe came in at 23%, or 19% at constant exchange rates. American growth slowed to 6%, due to the timing of certain sales events, but was up 19% on a constant basis. Demand in the Asia-Pacific region was also strong, suggesting that fears over a broad-based slowdown in the region may be unwarranted. Richemont, which posted its results on September 5, also reiterated its August forecast of 20-40% operating profit growth for the next 6 months. Burberry CFO Stacey Cartwright, cutting low-priced goods, said, "we know we are not alone in terms of what we've seen in the last couple of weeks [referring to sales slowdowns]." Richemont, however, reiterated its forecasts less than a week before Burberry's warning, suggesting that it is has not seen any such slowdown. We believe that Richemont would have cut guidance had sales worsened during the past month.
- Salvatore Ferragamo: Salvatore Ferragamo, an Italian luxury company that sells a variety of products, including shoes that can easily cost $1,000, is cutting low-priced goods, citing better-than-expected demand in both Europe and the United States. Revenues in the first half of 2012 grew by 22.9% for the company overall, and net income grew by 22.5%. In the second quarter, European revenues grew by 25.2%, driven by strong tourist demand, as well as newly renovated stores. The economic woes in Europe are not affecting all luxury companies equally. Both Salvatore Ferragamo and Richemont seem to be doing just fine in Europe, despite what Burberry says. And for Salvatore Ferragamo, China is doing fine as well. Revenue growth for the company's China division grew in the first 6 months of 2012, and has helped make Asia the company's largest market.
Simply put, we fail to see a pattern of consistently weak performance within the luxury sector. LVMH is confident about its second-half results, and is set to gain share (perhaps from Burberry?), and both Richemont and Salvatore Ferragamo are posting solid growth in their European divisions, as well as in other geographic segments. Many companies blame macroeconomic conditions when their results fail to meet expectations, and that may be the case here. It is not enough to listen to Burberry and assume that all luxury companies are struggling. Several of the largest players in the industry have provided upbeat commentary and forecasts for the second half of this year, which stand in contrast to the gloom coming from Burberry.
What is Tiffany Saying?
Tiffany's itself posted Q2 earnings on August 27, and the company's results were in line with expectations. Revenues rose by 2% in the quarter to $887 million. This is due in large part to a 9% drop in sales at the flagship New York store, which is because of a drop-off in European tourist demand. However, sales within Europe itself rose by 8% on a constant currency basis (down 1% on a reported basis). Tiffany's earnings call stated that its sales to foreign tourists were unchanged in the quarter, with decreases in European tourist sales offset by increases in sales to Chinese and Japanese tourists. Overall sales in the Americas were flat in Q2, while sales in Japan rose by 10% on a constant exchange basis (11% on a reported basis), and 3% for the entire Asia-Pacific region (2 % on a reported basis).
On its earnings call, management did lower its full-year growth outlook to 6-7% from 7-8%, to account for some increased uncertainty, as well as tough year-over-year comparisons. Executives did, however, reiterate their optimism about the company's long-term potential in China, where the company now has 19 stores. Tiffany's also stated that gross margins would drop in Q3, but rebound in Q4 as cost pressures related to diamonds ease towards the end of the year. Tiffany's earnings forecast was lowered slightly to $3.55-$3.70 per share from $3.70-$3.80 per share, to coincide with its reduced sales outlook. However, for long-term investors, Tiffany's should shine. Shares are down over 9% over the past year, and we believe that the mini-selloff the stock saw on the back of Burberry's news serves as a good entry point for long-term investors.
(click to enlarge)Tiffany's management said on the company's earnings call that its new earnings forecast reflects "an appropriate degree of near-term caution at this point in time." But, the company also said that it remains committed to meeting its long-term goals of 10-12% annual sales growth and earnings growth of 15%. And it is quite possible that management is being conservative in its earnings forecasts. We believe that Tiffany's is well positioned to meet its long-term goals. The company's brand is as strong as ever, and China and the Asia-Pacific region are still growing, which will serve to benefit Tiffany's in the years to come. We do not believe that Burberry speaks for the broader luxury sector, and think that Tiffany's best days are ahead of it.