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Tiffany & Co. (NYSE: TIF) is a prime example of an "affordable luxury retailer. The company sells high-end jewelry, diamond rings, and lower-priced silver jewelry in retail stores as well as through catalogs and e-commerce. A big part of the company's strategy has been focusing on higher-end jewelry in its product mix - almost one-third of Tiffany branded sales in 2008 were from gemstone jewelry with an average price of $3,300.^[1].

However, the recession that hit the American economy in 2008 through 2009 has forced even affluent consumers to cut back on their spending. American sales decreased by 11% while worldwide sales decreased by 3% during 2008. This decline was due in part to fewer actual transactions, meaning customers are buying less jewelry. Tiffany's international presence has been a benefit given the state of the American economy--strong Asian sales have helped make up for slacking American and European sales. On the other hand, the company's international presence can also be a disadvantage, given the fact that without hedging against exchange rate risk, the company's balance sheet is at the mercy of fluctuations of the U.S. dollar. Also, higher prices of gold and silver lead to higher production costs, which leads to thinner profit margins.

Company Overview

Tiffany & Co. sells its own brand of jewelry (approximately 88% of sales in FY09) as well as third-party designer brands in company-owned and franchised stores in the United States. Tiffany's flagship store in New York City is a vital source of sales for the company, as this one location was responsible for 10% of sales in 2008^[2]. Sales at this store, as well as other locations in major American cities, is heavily dependent on foreign tourist spending. The company is divided into segments divided by geographical location (contribution to 2008 sales are in parenthesis):

• The Americas (56% of sales) concern sales made in the U.S., Canada, Mexico and Brazil. In addition to its brick-and-mortar stores, Tiffany also sells goods to the U.S. and Canada through its website and catalogs.

• Asia-Pacific (32% of sales) consists of sales made to Japan, China, Korea, Hong Kong, Taiwan, Australia, Singapore, Macau and Malaysia. This segment operates chiefly through Tiffany boutiques in Asian department stores as well as the company website (for customers in Japan and Australia).

• Europe (10% of sales) consists of transactions conducted in the United Kingdom, Germany, Italy, France, Austria, Switzerland, Belgium, Spain and Ireland. Customers in England, Wales, Northern Ireland and Scotland are also able to purchase goods through the company website.

• Other (2% of sales) consists of wholesale sales of diamonds in addition to sales of Tiffany watches and eyewear.

TIF's net earnings and profit margin decreased in 2008 due in large part to the recession that has hit the American economy and sent ripples through foreign countries. The fourth quarter of fiscal 2008 saw a 75% decrease in net income. However, the company's earnings still beat wall street expectations through sales of its lower-priced merchandise and a cost-cutting campaign started by the company in anticipation of decreased sales. Tiffany was most affected by the decline of sales in the Americas. Sales of goods priced above $50,000 decreased the most. The company's flagship store, responsible for a relatively large portion of the company's sales, saw a 34% decrease in sales during the fourth quarter of fiscal 2009. For fiscal 2010 the company plans to open 13 new stores and focus on marketing in order to attract customers. The new locations will be smaller, 2600-square foot stores in which customers can handle the merchandise on their own without the aid of a salesperson. To cut costs further the company closed Iridesse, a chain of 16 stores that only sold pearl jewelry.^[3]The company predicts sales will decrease by 11% and earnings between $1.50 and $1.60 per share.^[4]

While sales in America are decreasing, sales in other regions have increased. 30% of Tiffany's 2008 sales in the gemstone segment came from Asia, with average prices of $3,300. Another 30% of sales in Asia came from diamond rings and wedding bangs, which had an average price of $3,000.^[3]

In the second quarter of fiscal 2010, the company's earnings and revenue decreased by 30% and 16% respectively. However, those decreases beat analyst expectations. In addition, costs were slashed by 15% from the same period the previous year. In addition, while other retailers are closing stores, Tiffany's store count increased 8% in fiscal year 2009 and it plans to increase its stores by 6% in fiscal 2010. Despite its expansion and cost-cutting, the company continues to struggle in an unforgiving retail environment where consumers are still reluctant to buy accessories.^[5]

Sales vs. Net Income for Tiffany Fiscal Years 2006-2008^[6]

The rest of Tiffany's sales come from timepieces and clocks; sterling silver merchandise, including flatware, hollowware (tea and coffee services, bowls, cups and trays), trophies, key holders, picture frames and desk accessories; stainless steel flatware; crystal, glassware, china and other tableware; custom engraved stationery; writing instruments; eyewear and fashion accessories. Tiffany also sells tablewares and timepieces from other manufacturers in its U.S. stores. None of the aforementioned product categories is responsible for more than 10% of total sales on its own.

Expansion into Other Markets

In 2008 Tiffany has made strides to enter the eyewear and mobile phone markets. Early 2008 saw the debut of Tiffany's new eyewear line, made possible through a deal with Luxottica Group, S.p.A. (LUX).^[9] In addition, Tiffany's partnered with Softbank to produce 8 diamond-encrusted cell phones, available for sale in Japan starting November 1st, that cost 13 million yen (or $134,000 USD) each. The phones sold out in three days.^[10]

Fiscal Q3 2009 (ended October 31, 2009) Earnings Performance

In fiscal Q3 2009, TIF posted higher-than-expected net earnings of $0.34/share, or $43.3 million. Net sales of $598.2 million also exceeded expectations and declined 3% from the previous-year quarter. In fiscal year 2009 year-to-date, net earnings were $127.5 million, compared to the $194.7 million in the comparable period of the previous fiscal year. Management took significant measures to increase balance sheet liquidity, with total cash and cash equivalents totaling $374.9 million, compared to $160.4 million from a year ago. SG&A costs and capital expenditures were also lower due to cost management strategies and fewer store openings. TIF raised its forecast EPS for FY2009 and Q4 2009 earnings to the range of $1.88-1.98, significantly higher than the street consensus of $1.77. ^[11]

Trends and Forces

Luxury Retailers, Especially Jewelers, Hit Hard By Economic Slump

Luxury retailers such as Tiffany appeal to customers in the upper-income bracket whose absolute spending power is usually not significantly affected by macroeconomic downturns. While the wallets of members of the lower- and middle-classes are significantly pinched during economic downturns, Tiffany's core customers have wealth that allows them to purchase jewelry with average unit prices above $3,000, and these customers are not as affected by downward trends in U.S. economic cycles. However, the recession that hit the country starting in 2008 and continuing into 2009 has affected even those upper-tier consumers. Domestic sales decreased by 11% in 2008 and worldwide sales decreased by 3%. Luxury jewelers across the board are feeling the pinch. For example, Bulgari's net income for 2008 was 75% less than net income for 2007.^[12] In this economy luxury companies cannot simply rely on their high-income consumers to weather the storm.

Exchange Rates: Major Risks and Rewards with Fluctuations Against the Dollar

Due to its large international segment exchange rates play a major role in Tiffany's performance. As the company doesn't engage in any significant hedging activity against exchange rate risk, the final amount of its sales and profits are greatly exposed to fluctuations in the value of the U.S. dollar. When the dollar falls against foreign currencies, such as the Japanese yen, Tiffany's sales in this foreign country become more valuable when translated back into dollars. For example, in the first quarter of 2008 Tiffany gained 15% on Japanese sales due to appreciation of the yen against the dollar^[13]. This is a major positive for Tiffany, as the dollar has been falling in value since late 2007 and a domestic recession would keep exchange rates in favor of companies with foreign sales.

Exchange rates also directly play a part in domestic sales as they influence foreign tourist spending. When the dollar is weak, U.S. goods are relatively cheap for foreign customers and this leads to higher sales from foreign tourists in U.S. cities such as New York, San Francisco, Las Vegas and other tourist-popular cities. This is particularly important in the New York flagship store where a majority of sales are from foreign tourist purchases.

Rising Commodities Prices Leads to Higher Production Costs

^[14]

^[15]

As a jewelry retailer, a large portion of Tiffany's costs relies on the costs of raw materials such as gold, silver and diamond. From April to May 2009, the prices of gold and silver have both increased. The increase in the price of raw materials leads to an increase in production costs, which leads to thinner profit margins. If the company does not raise prices to compensate for the increase in production costs then it makes less money per sale. Raising prices can have an adverse effect on Tiffany's sales given the economic state of the economy in mid-2009. Diamond prices, on the other hand, have returned to 2007 and 2008 levels^[16], meaning majority of production cost increase comes from increased gold and silver prices.

Competition

Jewelry shoppers are less price sensitive than consumers of other goods, and cost is often not the major factor in a purchase decision. Important points of differentiation are quality, service and image. Thus, smaller specialized jewelers are able to compete on a store-to-store basis against larger companies such as Tiffany. As such, Tiffany's competition comes from a variety of sources, including other specialty jewelry retail chains, department stores with jewelry operations and small jewelry shops. Tiffany's largest direct competitors include Signet Group (SIG), Zale (ZLC), and Blue Nile (NILE). Signet Group (SIG) Zales Blue Nile (NILE) retailers Tiffany faces competition from upscale and exclusive retailers such as Bulgari and Cartier.

Speciality Jewelry Retailers:

• Signet Group (SIG) is the world's largest specialty jewelry retailer in terms of sales, with $3.3 billion of revenue in 2008; the company is based in the United Kingdom and operates 1,959 stores in the U.K. and the U.S., including Kay Jewelers and Jared The Galleria of Jewelry chains in the United States. Signet Group exceeds Tiffany's in revenue and size; however the company currently lacks a presence in Asia. Tiffany, on the other hand, is in a good position to take advantage of new wealth developing in Asia due to the fact it already has stores in that region.
• Zale (ZLC) specializes in diamond jewelry and operates mostly mall-based stores as well as mall kiosks only in North America. It lacks an international presence, however makes up for it through volume in North America: The company has 2,135 locations throughout the United States, Canada and Puerto Rico. Both Zale and Tiffany sell low-priced jewelry, but Zale only extends to moderately-priced pieces while Tiffany seeks to maintain a "high-low" approach by selling $200 pieces next to $50,000 ones.
• Blue Nile (NILE) is the largest online-only retailer of certified diamonds and fine jewelry. The company's 2008 sales were much smaller than Tiffany's. The fact that the company sells its goods exclusively online makes it available to a wider audience than Tiffany's, whose goods must be purchased through its own stores.

Department Stores:

• Saks (SKS)
• Nordstrom (JWN)
• Wal-Mart Stores (WMT)
• J.C. Penney (JCP)
• Macy's Inc. (M)
• Sears Holdings (SHLD)

• Numbers in parenthesis are negative

References

1. ↑ Tiffany & Co. (TIF) 10-K 2009
2. ↑ Tiffany & Co. (TIF) 10-K 2007
3. ↑ ^{3.0 3.1} "Tiffany moderating, but not stopping, growth in '09"
4. ↑ "Tiffany profit beat lifts shares, but outlook dim"
5. ↑ Tiffany's is no bargain
6. ↑ Tiffany & Co. (TIF) 10-K 2009
7. ↑ Tiffany & Co. (TIF) 10-K 2008
8. ↑ Tiffany & Co. (TIF) 10-K 2008
9. ↑ Tiffany, Luxxotica Make Eyewear Pact
10. ↑ Just 3 days to sell out Tiffany Diamond Phones
11. ↑ TIF Reports Q4 2009 Earnings
12. ↑ Bulgari S.p.A. 2009 annual report
13. ↑ Tiffany & Co. (TIF) Press Release, First Quarter Earnings Release 2008
14. ↑ London Fix Historical Gold.
15. ↑ London Fix Historical Silver.
16. ↑ Tiffany & Company F1Q09 (Qtr End 4/30/09) Earnings Call Transcript.
17. ↑ Tiffany & Co. (TIF) 10-K 2009
18. ↑ Signet Group plc (SIG) Annual Report 2009
19. ↑ Blue Nile (NILE) Annual Report 2009