Shares of high-end jewelry retailer Tiffany (NYSE:TIF) have been sparkling lately, with its share price up almost 30% over the past 12 months, thanks to solid end-customer demand that has led to higher product prices and operating profit for the company. This is a trend that has also benefited competitor Signet Jewelers (NYSE:SIG). Tiffany's latest financial update was another dose of good news, as better-than-expected profitability sparked a big pop in its share price.
However, with a current adjusted P/E multiple of roughly 25, Tiffany's shares aren't exactly cheap, given that its top line only grew at a 10% compounded annual rate over the past four years. So, is the company still a good bet at current prices?
What's the value?
Tiffany is one of the major players in the high-end jewelry market, operating a network of almost 300 stores around the world, approximately a third of which are located in the U.S. Like other high-end retailers, the company's most valuable asset is its brand name, embodied in its trademark blue box; this allows it to generally sell its products at premium levels, consistently generating a gross margin in the high 50% range. The net result for Tiffany is a highly profitable business model that provides strong cash flow, funding its various growth initiatives, including a greater presence in emerging affluent hotspots, especially China.
In its latest fiscal year, Tiffany reported accelerating top-line growth compared to the prior-year period. This was evidenced by a 6.2% gain that was a function of higher average prices across its major segments as well as a further expansion of its overall store base, mostly in the Americas and Asia-Pacific regions. Despite being negatively affected by higher operating costs for its high-touch stores, a consequence of focusing on high-end customers, Tiffany took advantage of a better pricing environment to generate an uptick in its adjusted operating profitability. The higher profit provided the funds to continue investing in product development, including its new Gatsby and Atlas collections, while engaging in shareholder-friendly activities, highlighted by its 12th dividend increase in the last 11 fiscal years.
Of course, the question for investors is whether Tiffany can maintain profit growth over the long run, thereby providing support for its high-flying stock price. Based on the company's most recent quarterly results, the answer seems to be affirmative. This is evidenced by a 48.6% increase in operating income that was primarily the result of a continued uptick in average product prices, complemented by cost savings in its administrative overhead.
Fighting for the middle market
That said, there are downside risks to future profit growth for Tiffany, given that much of its future growth will likely hinge on its ability to attract more middle-market customers with its lower-priced product offerings, like its Rubedo jewelry brand. One of the biggest risks is the list of tough competitors that Tiffany will have to beat in order to win customer market share in the middle market, starting with segment kingpin Signet Jewelers.
Like Tiffany, Signet has benefited from strong consumer demand for jewelry, a trend that has led to a string of top-line gains, including a 5.7% increase in its latest fiscal year. More important, a greater availability of credit allowed Signet to generate more high-margin credit income during the period, helping its operating margin to remain at a double-digit level. The net result for Signet was strong operating cash flow, partially funding its acquisition-heavy growth strategy, as highlighted by its recent acquisition of Zale -- a deal that added more than 800 domestic stores, potentially making Signet an even more efficient competitor.
Also hunting growth in the jewelry space is consumer-goods marketer Fossil (NASDAQ:FOSL), a company better known for its diversified line of fashion watches. While Fossil generates the majority of its revenue from watch sales, it has been finding success in the fashion-jewelry category lately, as evidenced by a 26% increase in its latest fiscal year. More significant, the company has a huge distribution footprint, with sales in 150 countries at last count, making it a threat to Tiffany's ambitions in the middle-market space.
The bottom line
Shares of Tiffany have been on fire, thanks in large part to rising comparable-store sales that have translated into higher operating profit for the company. However, sustaining that performance over the long run would seem to be a difficult task, given the formidable competition that the company will face in the middle market. As such, prudent investors may want to wait for Tiffany to lose a bit of its shine prior to contemplating a position.