Tiffany remains a company that has one of the most bulletproof and inimitable brands, and fourth quarter results and guidance suggesting accelerating sales growth underline the solid underpinnings and staying power of the Tiffany name. Tiffany’s brand is the key driver of our narrow economic moat rating, which denotes the view of the sustainability of the company’s cash flows.
The company now believes it will return to growth in 2013 (mid-single digits), and diamond pricing trends and stability in inventory growth suggest to us that a more normal environment in 2013 is a reasonable assumption. Although most analysts agree with management that the company will continue to grow and fixed costs will leverage over the long run, the $59 consensus fair value estimate will move up only modestly, in part with the time value of money and also due to some increases in the cash flow forecast for the next few years.
Sales in the fourth quarter rose 4% to $1.2 billion, although in the largest (48% of total) Americas region, sales rose only 2% and declined 2% on a same-store sales basis. Sales in Asia including China again showed some rebound as quarterly results showed a 13% increase, compared with the 8% gain in the full year. Yet same-store sales rose 6% in the quarter and 2% in the full year. The trend is thus positive, but given that Tiffany opened approximately 21 stores in Asia on a base of 39 over the three years before 2012, and given that the Chinese economy is by government estimates still growing at more than 7%, we think there is room for some improvement.
Tiffany is underpenetrated in the mainland compared with peers, with only 26 stores, or less than half of the Asia region total, and less than one third of the 91 stores in the United States. For 2013, the company is projecting low teens growth in the Asia region and high-single-digit growth globally, suggesting the turn in trends will experience some momentum in the next year. Also of importance, is the inventory position, which, while it is still ahead of the sales growth rate–up 8% year over year–has slowed on the raw materials line as diamond prices have fallen and then stabilized.
Analysts’ view that some of the diamond price volatility following the big increase in prices in 2011 was in part due to speculation on inventory by various participants in the global value chain, and our view is that much of the speculative inventory has now washed out of the system. With finished goods and raw materials up just 2% at year-end, this bodes well for cash flow in 2013, although the company is guiding to operating margin leverage but slightly lower gross margins as the mix shift to higher-priced jewelry continues.
On an inventory basis, the company is forecasting only 5% growth, despite sales growth of 6%-8% and 14 new store openings. Although Tiffany’s vertical integration strategy offers advantages, including protecting and controlling the brand from end to end, the high value per piece and length of the inventory cycle can create a significant use of cash in some years.
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