Buy Tiffany bling, not shares

By Robert Walberg

Women may love the diamonds that come from its signature blue bags. But luxury retailer Tiffany (TIF, news, msgs) isn't offering much for investors.

Today Tiffany delivered weaker-than-expected quarterly earnings results despite a surprisingly strong 15% jump in sales. Though the stock is up more than 53% since bottoming last August, there's little sign of the sort of improvement that would propel the stock higher.

The company blamed the latest disappointing numbers on the rising cost of raw materials and on weak sales in Japan. In fact, gross margins dropped 1.6 percentage points to 57.2% -- a disturbing development. Tiffany said sales are running slightly ahead of plan in the current quarter, thanks in part by strong Valentine's Day sales. Yet it didn't forecast higher earnings ahead. In other words, the issues that depressed margins last quarter remain.

Struggling with costs

What's wrong? The company has struggled with the cost of materials such as silver, gold, platinum for several quarters. Though metals prices dipped a bit off their mid-2006 highs, they haven't eased Tiffany's pain. For example, silver is nearly $2 per ounce cheaper than the record, yet it is still almost twice the price of two years ago.

There is nothing on the horizon economically to suggest a major reversal in metals prices this quarter or this year. The best an investor can hope for is that the year-over-year changes will begin to flatten out.

Tiffany also cited a shift in its product mix for the decline in margins, as consumers are apparently moving toward higher-end diamonds. That's bad news for profit because margins are much lower on expensive items with high upfront costs.

The good news is that the company continues to attract high-end consumer purchases, a trend that could serve it well if the economy starts to slow. Higher-income consumers don't alter their spending habits as quickly as lower-income consumers during periods of economic contraction. Nevertheless, Tiffany must improve operating efficiencies or face the prospect of steadily declining profit margins.

No fix for Japan market

As for Japan, Tiffany has yet to come up with a cure for sluggish sales in the huge Japanese market. Relatively poor customer service and repeated failures to achieve the right product mix have resulted in soft sales for the better part of five years.

Again, there is nothing to suggest that management has resolved its problems in Japan so investors shouldn't expect an immediate improvement. Until management makes Japan a priority, a sustained turnaround in performance is unlikely.

Tiffany's current margin woes could be seen as a long-term buying opportunity if the stock were trading at steep discounts to its peers or the market. Instead the stock currently trades at 2.4 times trailing sales and 21.6 times estimated earnings, well above competitors such as Movado Group (MOV, news, msgs).

One reason the stock has held up is the recent investment by Triarn Fund Management. The hedge fund led by Nelson Peltz claimed it saw value in the company and bought nearly 5.5% of Tiffany's stock. But over five years, the stock hasn't done much.

Peltz's investment might keep Tiffany's stock from falling much below near-term support at $41. But investors should avoid the stock until management shows that it has fixed its margin problems.

At the time of publication, Robert Walberg did not own or control shares of any company mentioned in this article.