Well, they got me. Last week, after digging through Tiffany's (TIF +0.00%) filings, plans, and results, I wrote that I was "expecting Tiffany to be within analyst expectations. In part because those expectations have been tempered and in part because Tiffany is slowly moving out of the worst part of its most recent margin difficulty." Then, on Thursday, Tiffany rolled in with a meager $0.49 in earnings per share, while the market was looking for $0.63. So what went wrong?
Margin compression: 1; Tiffany: 0
One of the most important things for Tiffany to do last quarter was to manage its margins. Gross margins had been falling going into the quarter, but management was convinced that this was going to be a turning point. On the second-quarter call, CFO Patrick McGuiness said, "Product cost pressure is moderating, and we expect to soon benefit from reductions over the past year in precious metal and diamond costs. An expected year-over-year gross margin decline in the third quarter should be smaller than we experienced in the second quarter."
In the second quarter, gross margins fell 270 basis points from 2011. So based on management's projection, we should have seen a softer fall in the third quarter. This turned out to be false hope, and gross margins actually fell 350 basis points. So where did the unforeseen crush come from? Product mix. Tiffany ended up selling more high-priced pieces, which had smaller margins. In addition to selling the wrong stuff, the company failed to accurately gauge how fast diamond and silver costs would move through its books, and it didn't see the savings that it expected this quarter.
Predictable consumer behavior: 1; Tiffany's ability to predict: 0
If there was one key phrase to take away from the earnings release, it would be "bad forecasting." Let's illustrate this by looking back at what management said over the last few quarters. At the end of its 2011 fiscal year, investors were told that the company had "put together a reasonable and achievable financial plan for 2012 with approximately 10% worldwide sales growth." After the first quarter, that turned into "full year worldwide sales to increase about 7% to 8% for 2012." Second quarter: "we are now projecting net worldwide sales growth of 6% to 7% for the year." Now: "projecting full year sales to increase 5% to 6%."
It's worth giving the company a round of applause for its unbridled optimism, but that's about all investors should be cheering. Management needs to step back and reevaluate how it makes it forecasts, along with the moves that it made to grow the company. One of the main problems with last quarter was that the surprise in product mix showed Tiffany's inability to manage its consumers. The strongest retailers dictate what customers want, and lead the market instead of merely being subject to its whims.
Two companies that have done a better job in that regard are Coach (COH 1.89%) and Michael Kors (KORS +2.52%). Both companies have been leaders in their own way, with Kors leading the general fashion front and Coach making a play with its new and successful men's line. These are companies that aren't sitting back as customers come in looking for lower-margin products. Instead, they're making those higher-margin goods more desirable. That's how you lead the market.
In defense of Tiffany
I'm not a "one bad season and out" kind of guy, and I don't think that it's a healthy way for anyone to think about the stock market. Tiffany has been much better at this in the past. The company hit its 2010 growth estimate, and exceeded its 2011 estimate by a good deal. 2012 just seems to have flummoxed the models that it's been using to predict growth.
With its history of better performance, both in sales growth and in forecasting, I think Tiffany is still a company worth considering. That's especially true while the company is trading at a P/E of 18, which is below the jewelry industry average. But there's not a compelling enough reason to mark Tiffany as a buy until the backroom is back in order and sales start to move faster in the right direction.
