We continue our examination of Tiffany (NYSE: TIF) today. Last week, we said the inventory requirements in the jewelry industry would make it impossible for Tiffany to have a Flow Ratio below 1.25. We also said jewelry inventory doesn't face the same risks of obsolescence as technology products, which led me to conclude we shouldn't eliminate Tiffany from further consideration because of its high Flow Ratio.
Looking at Tiffany's cash flow from operations, poor management of working capital -- current assets minus current liabilities -- has taken a toll. Working capital is the lifeblood of any company because it represents the money that's available and ready to stick into the business. Current assets are assets a company expects to turn into cash in the next year, and current liabilities are expenses that will have to be paid in the next year.
We want Rule Maker companies to use their cash efficiently, which means bringing money in quickly and paying it out slowly. The more money a company has at its disposal, the more effectively it can run its business. The Flow Ratio gives us great insight into a company's working capital management, but so does cash flow.Looking at Tiffany's cash flow statement for 2000, the results are not impressive. It's important to look at cash flow because accountants are able to tweak the income statement to produce additional income. The cash flow statement prevents this type of airbrushing, and gives us insight into how much money a company is making from its core business.
($ millions) 2000 1999 1998 Cash Flow From Ops. $109.2 230.4 80.2 Net Capital Exp. $108.4 171.2 62.8 Free Cash Flow 0.8 59.2 17.4 Net Income $190.6 145.7 90.1
As you can see, there's quite a difference between cash flow from operations and net income. We'd prefer for the ratio of cash flow from operations to net income to equal at least 100%. Earnings are done in accrual accounting -- meaning revenue is recognized when billed -- just as expenses are recognized when incurred, instead of when cash is paid. The large disparity between cash flow from operations and earnings (net income) indicates the business isn't as robust as the income statement suggests.
The Cash King Margin helps us measure how efficiently cash is flowing through a company's business. We want companies to have a Cash King Margin of at least 10%. We aren't beholden to this number, but it's a good starting point because not every company produces this type of cash profitability. Unfortunately, Tiffany's Cash King Margin falls well below 10%: 0.5% in 2000, 4% in 1999, and 2% in 1998.
Year-over-year changes in assets and liabilities:
($ millions) 2000 1999 1998 Accounts receivable $10.2 $(12.7) $(6.2) Inventories (182.0) (13.4) (81.9) Prepaid expenses (3.9) (1.1) 1.9 Other assets, net (5.7) (10.1) (4.9) Accounts payable 11.0 (3.9) 10.6 Accrued liabilities 6.1 37.6 10.6 Income taxes payable (10.9) 20.6 8.1 Credits 5.0 7.3 4.2 Other liabilities 4.1 1.3 4.3 Total (165.2) 25.7 (53.3)
As you can see, increasing inventories make up most of the change in working capital, and the 10-K had this to say: "The company achieved net cash inflows from operating activities of $109,177,000 in 2000, $230,351,000 in 1999, and $80,178,000 in 1998. In 2000, the inflow was below prior year due to increased inventory purchases of finished goods and raw materials, partially offset by increased net earnings. In 1999, the inflow was greater than prior year due to increased net earnings and a decreased use of working capital."
Those increased inventory purchases decreased the company's cash flow from operations in 2000 and 1998 $165 million and $53 million, respectively. In 1999, when inventories didn't ramp up as they did in 1998 and 2000, Tiffany was able to produce more cash flow. Nevertheless, not only do we again see the toll that the inventory requirements can have on working capital, but also on cash generation.
Yes, the company's cash flow won't continue to hurt, if inventories come down. But even in a good year, when inventories didn't significantly increase, the company's Cash King Margin was well below par. This makes an argument for continuing to look at Tiffany even tougher, but there are a few more things I think we should learn about first before ending the examination. Next week, I'll discuss fashion risk and the threat it exerts on Tiffany's products.
Mike Trigg spends his days offering readers what Gordon Gekko called "the most valuable commodity": information. Mike's holdings can be viewed in his personal profile. The Motley Fool is investors writing for investors.