Valuentum Exclusive Analysis for the Discerning Investor

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A video that has been making the rounds challenging the markups at some of the high-end luxury dealers.

The widely-held thesis that the ultra-rich care more about status than function may be waning as convergence between the two ensue. Let's talk Tiffany and the ultra-luxury space.

By Brian Nelson, CFA

In August 2014, I talked Tiffany (TIF) on CNBC (https://www.valuentum.com/articles/20140828), and I warned viewers at the time that shares were a bit too pricey for our taste when they were trading north of $100 per share. Our fair value back then had been in the mid-$80s, where shares currently reside today, and since then, we’ve grown incrementally more bearish on the intrinsic value of the diamond seller; our fair value at the time of this writing is now in the mid-$70s. Tiffany is a prime example of a company that we love, but a stock that is too pricey for our taste. Remember--just because a company is a good one doesn’t mean its stock offers a bargain to investors. As an investor, you’re hoping to find bargains, as you would when you buy groceries when they are on sale at the store. Buying stocks for $0.50 on the $1 is the definition of investing, and owning quality businesses is only part of the equation.

For Tiffany, it’s all about brand and status, supported by extensive marketing. That little blue box, for example, may be worth more to the consumer than the diamond itself, and the negative buzz surrounding the vast mark-ups at the high-end luxury dealers continues, “I Want What It’s Worth.” The case is being made that mark-ups at Tiffany, Richemont’s Cartier (CFRUY), and Harry Winston (SWGAF) are considerable (~300%), perhaps playing into the hands of other producers that have similar (same?) diamonds but at much lower prices, namely Costco (COST) and Blue Nile (NILE). As millennials (MILN) continue to value experiences over “stuff,” the value of the Tiffany blue box may very well be challenged over the long haul. We think Tiffany’s brand and status will become ever-more costly to maintain as the years go on, and this will only pressure levels of profitability. The Internet has changed the game, and Blue Nile may be best positioned.

We may be witnessing cracks in the thesis regarding the importance of “jewelry or watches as status symbols” for the ultra-rich, too. The thesis many held with Richemont was the belief that the luxury watch giant would be able to hold at bay wearable technology produced by the likes of Apple (AAPL) and Fitbit (FIT). However, the market is learning that “being and looking healthy” is also somewhat status-like, and the convergence between status and function may have caught Richemont and others by surprise. On May 12, for example, Richemont released results for the its fiscal 2017 (ending March 31) that showed sales declining 4% at both actual and constant rates, while operating profit tumbled 14%. Here’s what Richemont had to say in its May press release:

The past year posed challenges for Richemont. The Group responded to changes in demand, which particularly affected our watch businesses, and shifting patterns of consumption.

If “being and looking healthy” is becoming a status symbol, and all signs are pointing that it is, Apple seems to be at the forefront of this wave, too. We’re not panicking over Richemont, as the company continues to generate tremendous cash flow from operations (€1.89 billion in fiscal 2017) and has a solid net cash position (€5.79 billion at the end of March), but underlying consumer trends seem to be moving away from the storied watch maker and into the hands of wearable technology, once shunned by the ultra-rich in favor of pricier alternatives. The concern with Tiffany may be much of the same, if well-documented millennial trends continue to proliferate, where attending shows from Live Nation (LYV), for example, may be much more important to the fiancée than receiving a bulky diamond ring in a blue box. Revenue in Live Nation’s first quarter, results released April 29, advanced an impressive 17%, while adjusted operating income leapt 25%. Times seem to be changing, as they always do. Just look at what is happening at the department stores and teen retail.

Now that said, Tiffany’s performance in its first-quarter report, released May 24, wasn’t terrible. Total revenue advanced modestly, and the company beat expectations on the bottom line, but global comparable store sales declining 3% wasn’t all that reassuring in the face of changing millennial preferences. Management attributed weakness in its Americas region to “lower spending by both foreign tourists and local customers,” and while we think this is true, we think the root cause of this may not be completely temporary in light of recent trends, perhaps best expressed by Richemont. On a constant-currency basis, comparable sales also declined in its Asia-Pacific and Japan regions, and were it not for Europe’s 3% advance, it would have been a clean sweep of weakness at Tiffany. Long-term investors in Tiffany’s equity have a lot to think about, in our view: In 20 years, will the blue box show off more status than the latest and greatest wearable gadget at that time? If current trends are any indication, it might not.

Luxury Goods - Established Brands: AVP, EL, HLF, LULU, NKE, NUS, PHG, PVH, REV, SIG, SNE, UA, VFC, VRA

Luxury Goods - Ultra & Aspirational: BID, CFRUY, COH, CTHR, FOSL, KORS, LUX, LVMHF, RL, TIF

Retail - Apparel (Teen-30yrs, Off-Price, Outdoor): AEO, ANF, BKE, COLM, CTRN, EXPR, GCO, GES, GPS, ICON, ROST, TJX, URBN, ZUMZ

Retail - Multiline: BONT, DDS, JCP, JWN, KSS, M, SHLD