Don't Hate Tiffany Because It's Resilient

Retail has been a tough place to be in the stock market during the past year. Many key retailers such as Macy's (M) and Wal-Mart (WMT) are facing tough cyclical and structural challenges, with many of the participants trading at multiyear lows. We believe this environment will last for some time as the tough macro, overstored U.S. market and rising e-commerce trends will continue to weigh on fundamentals. Some retailers will survive while others will struggle and maybe even go out of business. Nevertheless, structural change hasn't caused all the problems. In certain instances, just a tough macro environment led by international and luxury consumers is leading to shortfalls. We believe this will be more temporary than the new normal. One such retailer that we find near-term challenged but will ultimately find its way back to prosperity is Tiffany (TIF). Business trends have been difficult in 2015 and beginning in 2016, with projected yearly revenues and earnings per share stuck in the $4.2 billion and $3.85 ranges, respectively. Importantly, we think TIF's issues relate to short-term economic trends, rather than long-term secular issues (the Internet). The fourth-quarter holiday sales were particularly disappointing, with global comp sales down 5% while total sales for the period were down 3%. Europe and Asia/China were both negative while Japan surprised to the upside, gaining 10%. However, the greatest surprise came from comps, down 8% from the Americas region (investors were looking for positive numbers here). The greatest detractor from the Americas region was a decline in foreign tourism sales, which were down 30%. However, the mainstream customers also curtailed spending during the quarter due to macro concerns from the sluggish economy and volatile stock markets. There are really are no signs of any turn in the business. Fortunately, what the numbers are showing is that profitability margins are holding steady, with gross margins at 63%, operating margins at 25% and net margins at close to 12%. Furthermore, Tiffany also continued to generate a strong high-teens return on equity ratio (ROE) and robust free cash flow equal to net earnings. If the business had structural issues, these numbers and ratios would not hold steady at such high levels. A turn in the fundamentals may take time. However, the price is reasonable, the company has solid long-term growth prospects, and the brand protects it from many of the challenges that are hurting the Macy's and Kohl's (KSS) of the world. The Tiffany brand is still the envy of the jewelry markets and that is not being challenged. The firm also has multiple opportunities to expand its 309-store base much further. There is no reason Tiffany can't have 500 to 600 stores eventually. The balance sheet is solid, with almost no debt (less than $400 million), $3 billion in shareholder equity and $8 billion in market capitalization. The shares are reasonably priced at a little over 16x earnings. The shares have traditionally traded for 18x to 20x earnings. The company pays a nice 2.4% yield. While there is limited near-term visibility, we believe Tiffany's will be a long-term winner in the retail space. The current challenges are only temporary vs. the more structural concerns across the rest of the retail space. For investors looking to take advantage of the retail selloff but are having a difficult time handicapping the winners and losers, TIF is a sound investment.

Don't Hate Tiffany Because It's Resilient

Economic trends have been tough, but if any retailer can survive, TIF can.

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