Tiffany Is Top-Drawer

Prestige jeweler Tiffany (NYSE: TIF  ) earned high marks from investors this week, its shares rising 14% in response to a Monday earnings report that bested analyst expectations.

You've probably heard the basics by now:

  • Sales rose 15% for the year, slowing toward year's end to a 10% gain in the fourth quarter.
  • Same goes for profits, which rose 20% for the year but fell 16% for the quarter.

You've probably also heard a bit of the "between-the-lines" commentary on Tiffany's news. For example: Multiple "one-time charges" hurt net results, international sales saved the day, same-store sales were pretty weak, and management is predicting continued weakness in the first half of 2008.

Yet overall, analysts seemed to like what Tiffany had to say, in particular about this year. Management upped its annual guidance by roughly $0.30 per share, and it now predicts that 2008 "adjusted" (i.e. pro forma) earnings will come to $2.75 to $2.85 per share on 10% sales growth.

This comes in part from a change in how Tiffany accounts for inventory. Management is dropping its LIFO (last in-first out) accounting procedure, and will henceforth calculate profits based on the average cost paid for inventories. (This could magnify profits when inventory purchased back when prices of gold, silver, and diamonds were below today's levels gets sold at today's inflated prices.) But it's also a happy consequence of the company's success in foreign luxury markets, where Tiffany predicts "robust growth in our non-U.S. markets other than Japan."

Iron pyrite earnings
Tiffany's news helped pull other jewelers' stocks up earlier this week, with shares of Blue Nile (Nasdaq: NILE  ) , Zale (NYSE: ZLC  ) , Signet Group (NYSE: SIG  ) , and Harry Winston Diamond (NYSE: HWD  ) riding Tiffany's coattails. That may be the right move in general, based on the trends Tiffany is outlining. But as for Tiffany itself, I have to admit that I'm still not convinced this stock deserves its recent rise.

My objections to Tiffany center on valuation. The shares already look pricey at 18.4 times last year's earnings, despite analyst estimates of 13% annual growth going forward (and despite having grown at barely half that rate over the last five years.) And as I described back in January, Tiffany looks even more expensive based on cash profits. Tiffany did not include a cash flow statement with its earnings release, so we necessarily must work with dated information here. But as of last quarter, the firm was generating less than half the free cash flow ($154 million over the trailing 12 months) that it reported as GAAP profits ($326 million).

Unless something changed drastically in Q4, this stock is still selling for well more than 30 times cash flow, while growing its profits somewhere in the low-to-upper teens. That's a high price to pay for prestige.

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