7/11/2011
By Brian Sozzi, Research Analyst

Tiffany's (TIF) stock price is at an all-time high.  Since the latest bout of market weakness commenced on May 2, Tiffany has risen 18% compared to a 3% slide in the S&P 500.  Correcting equity markets?  Fuggedaboutit.  Signs of moderating economic growth in emerging markets?  Who cares when it comes to Tiffany, right?  The disappearance of the U.S. aspirational shopper?  No matter, Tiffany will make up the difference by selling pricier pieces to tourists carrying stronger currency to its U.S. stores.  So why with the U.S. retail sector basically resembling a battlefield with price wars on bland products being the new normal is Tiffany's stock price sparkling?  It goes well beyond the company being the only true mechanism for investors to play the high-end consumer, it boils down to inventory valuation and the dramatic appreciation in prices for gold and diamonds dating back to March 2009.

Inventory is Tiffany's largest balance sheet asset, representing 45% of total assets as of April 30, 2011.  Tiffany uses the average cost method to value its inventory, which assumes that the cost of inventory is based on the average cost of the goods available for sale during the period.  Essentially, Tiffany has been in a sort of sweet spot the last two years, selling its flashy inventory bought at depressed prices relative to where the market is presently standing.  The strong global demand resurgence has allowed Tiffany to jack up prices with relative  ease.  Pricing power plus cost advantages is a winning combination for margins (gross margins have expanded year on year for six straight quarters).

Consider this; over the last five years Tiffany's inventory has taken an average of 418 days to turn once (Coach's five-year average is 146 days; Movado's five-year average is 384 days), suggesting that the margin sweet spot could be maintained at least until 4Q12 (when current gold and diamond prices comprise inventory to a greater extent) seeing as Tiffany does not discount.  The sell-side actually doesn't expect Tiffany's gross margins to decline on a full year basis until calendar 2013. 
Looked at from another angle, Mr. Market is saying that Tiffany's inventory is worth more than the carrying value on the balance sheet; inventory was bought at less inflated prices and if it were to be liquated today at the market, would be worth more.

Brian Sozzi
Wall Street Strategies

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