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Monday August 09, 2010
Tiffany (TIF): 'Little blue box' buy
by John Buckingham, editor The Prudent Speculator  At some point, the bearish outlook on consumer spending will become a crowded trade, as too much focus on risk threatens to blind one to opportunities that the ongoing pessimism and market turmoil have created. While we are not clamoring to add new names with general retail exposure, the receding tide has brought low all boats, including Tiffany & Co. (TIF), a company with a ubiquitous worldwide brand. Tiffany dominates its specialty retail niche and with growth targeting arguably the healthiest part of the consumer spectrum, the high-end international customer. Tiffany has created a pervasive global brand despite operating only 220 stores worldwide. The coming store growth, funded by ample free cash flow, should therefore have a amplified effect on the financials. Over the next five years, the company plans to open upwards of 20 new stores in China to go along with six in the Americas and three in Europe, expanding the share of revenue coming from overseas from an already lofty 60%. 
With healthy customer demand and smaller, more efficient stores, operating margins on locations in Asia exceed 25%, versus about 17% for the counterparts in the Americas. That difference will magnify the already large gap between Tiffany’s high-teens operating margins and those of even the best competitors, which rarely rise above 10%. The jeweler is also distinguished from the rest of its retail peers by its pricing power. The company raised its prices worldwide in February and still saw growth in jewelry demand in the first quarter, especially in items priced over $50,000. It is a stark contrast to aggressive price cutting and heavy discounting underway at almost every other retailer. Pricing power also continues to insulate Tiffany from volatility in precious metals prices, which have increased dramatically. For reasons unknown to us, that strength has not prevented the stock from pulling back almost 25% from its late-April high, far more than the 18% or so decline in the broader retail index. Tiffany is not standing still, however. The company has refocused on streamlining inventory management, reducing its investment in working capital by better than $160 million. And, as its existing stores require little in the way of ongoing capital expenditures, free cash flow topped $600 million in the fiscal year ended in January. At current prices, that equates to a tantalizing free cash flow yield of better than 10%, prompting the company to raise its dividend—the payout rate is now 2.4%—and resume its $400 million share repurchase program. While the stock does not appear to be as inexpensive as other retailers on a price-to-earnings ratio, for example, we believe that Tiffany’s enviable brand moat, Asian-focused growth profile and cash-flow generation capability are well worth the slight premium. We also can’t put a price tag on the fact fact that there is something extra special about treasures packaged in a blue box with a white ribbon! Learn more about this financial newsletter at John Buckingham's The Prudent Speculator. |
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