How Tiffany Plans to Shine Forever: The Advantage of Pricing Power

Tiffany & Co. (NYSE: TIF  ) showed investors once more the power of its 150-year-old brand, said to be worth $5.16 billion, when it reported robust third-quarter results on Nov. 26. A sterling earnings per share figure of $0.73 cents, combined with roughly $95 million in net earnings, caused its shares to rise more than 8%. The latest market rally has helped to consolidate Tiffany's position as one of the best performing luxury companies this year, well above Coach's (NYSE: COH  ) 0.1% year-to-date return.

Given the luxury goods industry's highly competitive nature and strong sensitivity to macroeconomic cycles, Tiffany's ability to sustain its pricing power and find new markets will remain a central issue for investors. Although the industry has seen innovative competitors such as Michael Kors Holdings (NYSE: KORS  ) emerge quickly, Tiffany's strong brand, built over 150 years, could protect the jeweler from potential challengers. To assess Tiffany's economic moat, we will dig a little deeper into the company's history and filings.

How to build pricing power in a highly competitive space
It all started in 1837, when Charles Lewis Tiffany borrowed $1,000 to open a small pottery and umbrellas store in New York. The company went on to become a multinational luxury jewelry and retail empire, selling silver, china, fragrances, leather goods, and the dream of ultimate taste and style in fashion.

It's no secret that whenever a crisis is near, consumers first cut their discretionary budgets. After all, few people can afford diamonds, and fewer still in times of crisis. However, over its long history Tiffany has managed to survive more than one recession thanks to its amazing pricing power. This pricing power allows the firm to enjoy a 59% profit margin, far above most retailers. This is possible because most consumers see Tiffany as a high-value brand. In more than 150 years of accumulated marketing expenditure, the company has ingrained in our minds the idea that its blue boxes are the ultimate expression of romance and happiness. Moreover, to protect its exclusivity, the company has maintained high price points.

Tiffany and Asia
In the latest quarter, the company's revenue came in at $911 million, surpassing most analysts' estimates by a wide margin. Given its large scale of operations, to continue improving its top line performance the company needs to maintain its wide share in mature markets, like Japan -- which contributed $128 million to Tiffany's third-quarter total revenue. It will also need to strengthen its position in emerging markets, particularly those within the Asia-Pacific region where increasing nominal per-capita income promises to become a growth catalyst for most luxury brands.

Coach, for example, is capitalizing on China's middle-class aspirations and projecting $530 million in sales for 2014. This is a massive improvement since 2010, when the company reported only $100 million in sales. Expansion in China also means more scale advantages and lower operating costs, and therefore Coach is likely to benefit from higher margins in the coming years.

Aware of the importance of this region, Tiffany is set to continue its geographical expansion. Its presence in the Asia-Pacific region is still limited. The company has 68 stores in the whole ex-Japan Asia-Pacific region, four more than last year. This figure is still low, as just in Japan there are 54 Tiffany stores. A wider presence in the region could help Tiffany improve its top-line performance, and offset the negative effect of a weaker yen.

Compared with Tiffany and Coach, Michael Kors is in a very early stage of expansion in Asia. According to Reuters, the company had only four stores in greater China last year, operated by licensees, and ten stores in the entire southeast Asian region. Because luxury goods sales in China are expected to hit 74 billion euros by 2020, with sales of high-end watches leading this growth, Michael Kors is also expected to open more stores in this region.

Foolish bottom line
Tiffany just delivered a great quarter, showing investors that its 150-year-old brand remains as powerful as ever. Further expansion in Asia, combined with strong pricing power, should help the company remain a cash generating machine in future quarters.

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