The S&P 500 is up only 6% year-to-date. That is good but not great relative to 2017’s near 20% return. That being said, 2018 has had its fair share of big winners.
One of those big winners is diamond and jewelry retailer Tiffany (NYSE:TIF). TIF stock is up 30% YTD, thanks largely to improved macroeconomic factors boosting jewelry demand and the company’s big marketing efforts growing brand awareness.
The combination of those two tailwinds has powered strong operating results for Tiffany over the past several quarters, and those strong results have pushed TIF stock to all-time highs.
But, the investment community is growing cautious on TIF stock at these levels.
Edward Jones downgraded TIF stock to “Hold” in late June. Bank of America Merrill Lynch scratched TIF stock off its top-buy list in early July. And most recently, Oppenheimer cut TIF stock to a “Perform” rating in early August.
The reasoning behind the sudden caution? TIF stock has come very far, very fast. Valuation is above historical levels. And, go-forward growth prospects aren’t all that great, especially considering recent yuan devaluation (the devaluation gives Chinese tourists, a big demographic for Tiffany, less buying power).
I agree with this broad caution on TIF stock. The growth story today isn’t all that much better than it has been over the past five years. Yet, the stock’s forward earnings multiple is nearly 35% above historical levels. From this perspective, it looks like we have a case of a slowing growth narrative converging on a big valuation.
That convergence usually results in a weak stock.
Here’s a deeper look.
The Fundamentals Supporting Tiffany Aren’t Great
At its core, Tiffany is a premiere diamond and jewelry retailer with a strong brand image. Consequently, not only does this company operate in an industry with enduring demand (people will always buy jewelry), but the company is also arguably the most desirable and popular mainstream option in that industry.
Because of this, the long-term fundamentals supporting Tiffany are stable and good. But, they aren’t great.
This is a company that has struggled with millennial demand over the past several years due to younger consumers pushing back big life events like marriage, spending more on traveling than on products, and simply not valuing expensive jewelry like their parents.
In order to regain those lost millennial customers, Tiffany poured a bunch of money into targeted marketing, and the results have been solid thus far.
But, this still isn’t a big growth industry. Over the past several years, with millennial jewelry shopping down, revenues increased less than 1% a year. Now, with millennial jewelry shopping back up, sales are up just 6% so far in 2018. That isn’t big growth. Thus, going forward, Tiffany is probably a sub-5% growth company.
Meanwhile, what is powering this rebound in sales is a bunch of marketing spend. It remains to be seen if Tiffany can grow sales at a healthy rate without the big marketing spend. Consequently, on a go-forward basis, margins will likely remain under pressure as the company continues to invest in order to sustain revenue growth.
The big picture is that revenue growth is back, but the growth isn’t that big nor is it that high quality. As such, the long-term fundamentals supporting TIF stock are good but not great.
Valuation Is Over-Extended
Unfortunately, the fundamentals need to be great in order to support TIF stock at current levels.
The current forward earnings multiple is nearly 29. The trailing five-year average forward earnings multiple is 21.5. That means that TIF stock is currently trading nearly 35% above its historically normal valuation.
But, as stated earlier, the fundamentals on a go-forward basis really aren’t that much better than the fundamentals on a trailing basis. They most certainly are not 35% better. Thus, today’s 35% valuation premium seems a tad rich.
Long-term, this is a mid-to-high single-digit revenue growth company with healthy gross margin drivers, but structural changes in the jewelry market will keep margins relatively depressed due to high marketing spend. Assuming healthy revenue growth, some margin expansion, and a healthy share buyback rate, I think Tiffany can do about $7.30 in earnings per share in fiscal 2022.
A historically average 21.5x forward multiple on $7.30 implies a fiscal 2021 price target of $157. Discounted back by 9% per year (lower than my usual discount rate due to Tiffany’s stable business model), that equates to a fiscal 2018 price target of ~$120.
Bottom Line on TIF Stock
Recent caution from Wall Street analysts regarding TIF stock is warranted. This is a company with a stock price that has sprinted ahead of fundamentals in the near term. Expect this stock to trade sideways over the next 8 to 12 months before taking another leg higher.
As of this writing, Luke Lango did not hold a position in the aforementioned security.
