Tiffany Loses Her Luster

Tiffany & Co. (TIF) is off between 4% and 6% in early trading after the company announced second quarter earnings.  The price action continues to underscore the weakness in the luxury retail industry.

Optimism for a sustained economic recovery is now giving way to the harsh realities of our current environment – complete with:

• Persistent unemployment
• Anemic economic growth
• Destruction of wealth
• Potential for extended stagflation
• Increasing global protectionism
• Rising levels of investor fear

It’s interesting to note that Tiffany’s report was actually not particularly horrible.  Revenue increased 9.2% although sales still came in well below analyst expectations.  Earnings of 55 cents beat analyst expectations and represented a gain of 41% over the same quarter last year.  Gross margins actually widened to 57.8% from 55.1% last year, due to increases in pricing.

Management even had positive things to say about the company’s future prospects:

“We look toward the second half of the year with a sense of guarded optimism, continuing to grow our worldwide store base and launching a range of exciting new products, including an extraordinary collection of jewelry with yellow diamonds and an enticing new collection of handbags and leather accessories, among many others.

“So far in this third quarter, consolidated worldwide sales are growing at a low-double-digit percentage rate over last year, with varying results by region. And, as our sales grow, we are efficiently utilizing our infrastructure to further increase the operating margin.

“Therefore, based on our better-than-expected second quarter results and expected continued strength in gross margin, we are increasing our annual net earnings outlook to $2.60 – $2.65 per diluted share (from $2.55 – $2.60 previously), although earnings growth in this third quarter (versus last year’s $0.33 per diluted share excluding nonrecurring items) will be somewhat restrained by disproportionately higher marketing spending.

“Tiffany remains strategically and financially well positioned.”

Michael J. Kowalski , CEO – Tiffany & Co.

TIF is currently trading near 15 times expected earnings for this year (fiscal year end is Jan 31).  That’s not an excessive multiple for a luxury retail company that is experiencing stable growth in a healthy economic environment.  But with today’s risks stemming from slow global growth, coupled with a growing aversion to luxurious expenditures, this multiple could eventually be cut significantly.

One has to ask why management is expecting “disproportionately higher marketing spending…”  Is it because the company is having trouble meeting internal (or external) growth objectives and has to push harder to get the consumer to spend?

And what happens if these higher marketing expenses don’t pan out?  Doesn’t that mean margins will end up being constrained instead of the optimistic “increased operating margins” forecasted in the report?

Tiffany & Co. is currently a $5.13 billion dollar company with sales of roughly $2.9 billion over the last four quarters.  That’s an impressive base for the record books, but even in the best of times it is challenging to grow this extraordinary figure.

It appears the risks far outweigh the potential returns for Tiffany bulls.  From a trading perspective, I would be much more comfortable finding proper inflection points to initiate short exposure and add to that exposure over the course of the next few months.