Understanding Tiffany

Tiffany & Co. (NYSE: TIF  ) turned in spectacular revenue growth of 18% and same store-sale growth of 16%. International sales were up 11%, and same-store international sales jumped 5%, if you back out the effect of strengthening foreign currencies, especially the Japanese Yen.

And yet earnings are down 20% from last year, and the stock is getting hammered to the tune of more than 7%. I recently sold my Tiffany stock, as I thought it had grown very expensive, but the sell-off today on what will be several times normal volume has the hallmarks of a panic, where the actual story from Tiffany remains decidedly positive.

The reason earnings are down so substantially is simple -- this quarter last year, Tiffany had the benefit of a one-time tax credit for foreign source income that took its tax rate down from a normal 33%-36% to 20.9%. This quarter's tax rate came back to 36.6%, and so nearly identical earnings before taxes resulted in dramatically different bottom lines.

Tiffany reported much better sales in high-end jewelry and some softness in silverware. On the conference call (transcript courtesy of CCBN), Tiffany Vice President Mark Aaron said that the strength was in "jewelry in the $5,000 to $50,000 range, but also with healthy growth in jewelry sales and transactions above $50,000."

These big ticket items, as one might expect, have somewhat lower gross margins than tableware and other goods -- the same areas where Tiffany's sales were not as strong. Partly as a result, the company's overall gross margins declined from 59% to little more than 55%.

Here's the thing that's most perplexing about the market's reaction: The company raised its expectations for the fourth quarter. Generally, we don't care much for guidance and beat-the-street games, but in Tiffany's case, the fourth quarter is the most important of the year by far. By upping its guidance, Tiffany is stating that its most important quarter of the year -- accounting for nearly half its earnings -- is shaping up to be quite strong. And yet, investors are selling, seemingly in response to a "weak" earnings report that really wasn't. Perplexing.

At the outset of this story I stated that I had recently sold my Tiffany stock. This was not due to any lack of confidence in the company -- frankly I'm much happier being a Tiffany shareholder than not being one. Rather, I came to believe that the stock's gains over the last 6 months were decidedly overdone, to the point where it outstripped the margin of safety.

But few brand names are as powerful as Tiffany's. There should be very little question that the company turned in another powerhouse quarter, damn the bottom line.

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