Summary
Always a well managed business, Tiffany faces a host of uncertainties that are out of management's control for the time being. Here's more.
Analysis
Tiffany reported a 62.3% decline in earnings for its first quarter ending April 2009. That decline in profitability was the consequence of a substantial decrease in sales, especially in its New York flagship store. According to the company, sales plummeted 42% there, while it total North American sales declined 31%. Those declines are in line with the magnitude of sales drop the company experienced during the November-December period last Christmas.
According to a Tiffany spokesperson, sales declines in the first two months of the second quarter had moderated slightly, meaning the company expected a relative improvement in July. But, actual sales may well be less than originally expected after Vice President Biden said the administration had underestimated the depth of the recession. That, along with a decline in commodity prices, shocked investors, driving the DJI down about 4% during early July. It probably shocked luxury buyers too reawakening fears that market gains were a false start, which can only serve to reinforce their current depressed spending habits.
Just how well Tiffany will do in the second half of the year is problematic. Despite being a well-managed business, the company is up against a number of forces that are just out of its control, namely, the recession, which now shows little likelihood of abating in 2009. In fact, whatever optimism that remains about fall luxury sales growth is no more than conjecture, because the numbers just don’t support any improved sales scenario.
Declining sales may not be Tiffany’s only problem. They could also face some balance sheet jeopardy. As of the end of January 09, the company had about $1.6 billion in inventory. That was about $229 million more than the previous year. The company’s first quarter balance sheet shows inventory had declined to about $1.55 billion, which is a negligible decrease. Under normal circumstances, the extra inventory would mean higher carrying costs that could be offset by incremental sales, but that isn’t the issue now. The issue is the market value of the diamond inventory.
According to the Rapaport TradeWire, “polished [diamond] prices [were] softening with some discounts exceeding 40% below list.” Moreover, “recent rough [diamond] price increases appear[ed] unsustainable. Clearly, the economics of diamonds has changed. Once jewelers had a high expectation that unsold diamond inventory would be more valuable the following year. Now that isn’t certain. In fact, with both rough and polished diamond prices at the mercy of the market, Tiffany could find the book value of its diamond inventory overstated at year’s end. That’s an uncertainty most investors have never had to factored into luxury jewelry company’s valuation. But, that may need to change.
Up until 2001, DeBeers controlled diamond prices by manipulating the supply of the various qualities and sizes of diamonds. Now, the availability of diamonds fluctuates according to a complex set of variables including consumer demand, producing countries need for hard currency, NGO’s mandates, and host of subtle political variables, all of which have destabilized diamond prices over the last decade, but especially during the recession.
Just what the value of Tiffany’s diamond inventory is today is uncertain. Rough prices have declined as much as 50%. Some large diamond cutters won’t sell larger stones, choosing not to establish a lower base price. However, if the recession drags on, as many think it will, substantially lower prices are inevitable. Even though some of the privately owned mining companies have shuttered operations to prop up prices, the revenue needs of third world governments will eventually keep the pipeline full, meaning there is little incentive for any of the producers to limit production. It that psychology materializes, it will be a seminal change, transforming how jewelers buy diamonds and what consumers are willing to pay for them.
Whether that means more diamond business in the future or less is debatable, but it does mean inventories kept on the books for a year or more could be subject to downward valuation. That could mean CEO Michael Kowalski’s projection that Tiffany would “remain, solidly profitable and will generate substantial cash from operations’ may be more conjecture than a historical certainty.
