Tiffany (TIF) reports so-so 4Q12 earnings

the results

Before the opening bell this morning on Wall Street, TIF reported 4Q12 (the company’s fiscal year ends in January) results.  Sales were up 4% year on year during the quarter, at $1.2 billion.  Net earnings were up 1% yoy, at $180 million.  That works out to eps of $1.40, vs. the $1.39 reported for 4Q11.  But it was $.04 above the brokerage house consensus of $1.36.

For the full year, sales were up 4% at $3.8 billion.  Net income was $416 million, down from $465 million in fiscal 2011.

In its earnings release, TIF also gave its first guidance for fiscal 2013.  It expects sales to be up by 6%-8% and eps to move roughly in line–but possibly with a touch of positive operating leverage evident later in the year.  1Q13 will be relatively weak (TIF fingers marketing costs and high raw material prices as the culprits), but earnings comparisons will likely improve from then on.

As I’m writing this, shortly after the open, TIF shares are up almost 3% in a market that’s up by about half a percent.

I don’t see why.

my take

TIF is an exceptionally well-managed company with a powerful brand name in the Americas and the Pacific, and in a business, luxury goods, that has strong long-term growth prospects.

This is the first time in five quarters that TIF results have exceeded the Wall Street consensus.  That’s a plus, although the “beat” is at least partly due to analysts’ low-balling their estimates after having whiffed four quarters in a row.

Management guidance of 6%-9% eps growth for fiscal 2013 is also a low-ball number, in my view.  I think +10% is easily attainable but believing in +15% would be a stretch.

my issue is valuation

I’ve owned the stock in the past but don’t now. Based on management guidance, the stock is trading at 20x year-ahead earnings, which is about as high as the PE has gotten over the past decade.

–Yes, there have been short periods when the multiple has spiked higher, but who wants to count on this happening again.

–Yes, there may be another, say, 5% to count on in the stock as earnings come in better than guidance.  But a professional investor should be looking for the potential +30%s and the +50%.  There’s just not enough upside here.

–Yes, there’s recurring speculation that some EU luxury conglomerate may buy TIF.  But, again, is this enough of an investment thesis?  In my view, no.  If the stock were trading at 15x earnings, however, it would be a different story.

what catches my eye in the release

TIF still doesn’t have its balance sheet completely back under control.  A while ago, when world economic prospects looked brighter, TIF decided to boost its inventories significantly.  That was so as not to lose sales for lack of stuff to sell, as well as to support a quickened store expansion plan.    …an aggressive, but very sensible strategy.

As global growth started to fade, TIF put on the manufacturing brakes.  But at 1/31/13, inventories were still $161 million higher than a year earlier.  And debt, net of cash, was up by $176 million.  That’s the reason, I think, why TIF bought back no stock during 4Q12, despite the fact the shares spent much of December in the mid-high $50s–vs. TIF’s full-year average buyback price of $66.54.

Comparable store sales in the Pacific, ex Japan and ex currency effects, were +6% for 4Q12.  I interpret this figure as saying sales there, which I view as the key factor that could make fiscal 2013 surprisingly good for TIF, have passed their low point.  TIF is penciling in a “mid-teens” total sales increase for the region–implying, I think, +10% for comparable store sales.  In a better Chinese economy and with clarification of the new government’s view on luxury goods consumption, that figure may be way too low.   If there’s one thing TIF bulls should monitor, this is it.  If there’s one thing that could change my mind about the stock, this is it.

my take on the Cyprus financial crisis

background

Cyprus is a Mediterranean island-state with a population of about 1 million and an annual nominal GDP of around US$24 billion (€18 billion).  The country joined the EU in 2004.  At that time, the union was still in a phase of wanting to be all-inclusive.  But even so, perhaps the only member enthusiastic about Cyprus’s entry was Greece, because of the two nations’ close business and ethnic ties.  As I understand the situation, it took a Greek threat to blackball other prospective members, like Poland, before Cyprus was allowed to slip in the door.  Cyprus joined the eurozone in 2008.

Why the reluctance?

Low tax rates have given Cyprus a long-standing reputation as a tax haven.  But after the collapse of the Soviet Union and the subsequent efforts by the nomenklatura in member countries to abscond with the national wealth, Cyprus is thought to have welcomed the cash of all comers, without being overly finicky about the source or legal status of the tidal wave of money it was receiving.

With its entry into the EU, Cyprus began to exert an even greater magnetic attraction for wealthy Russian immigrants seeking citizenship–and the access to the rest of the EU that a Cyprus passport would bring.  Deposits by foreigners into banks in Cyprus also ballooned.  About 40% of the almost €70 billion in bank deposits the Cyprus banks are thought to hold, are estimated to be from foreigners, most of them Russian.

How did the banks get into trouble?

The influx of cash gave them more money than they knew what to do with.  So they lent  …crazily.  A large chunk of loans went to Greek businesses, and a lot more was “recycled” into Russia and other parts of the old USSR.  The banks bought a large helping of Greek government bonds, as well.  And they funded a local property bubble.

How bad is the situation?

from Cyprus’s point of view

Because of the way they operate, the banks in Cyprus are gigantic in relation to the size of the country.  To get a sense of how big, consider the United States.  According to the Federal Reserve, the total of deposits in commercial banks in the US is $9 trillion, give or take, or about 58% of GDP.  Deposits in Cyprus banks are almost 4x that country’s GDP.

The bailout of the Cyprus banking system proposed by the European Central Bank and the International Monetary Fund is €17 billion.  Of that, €10 billion is supposed to be coming from the EU/IMF.  The other €7 billion is supposed to come from Cyprus–an amount that’s almost 40% of GDP.  Where can/will Cyprus get its share of the money?

A standard remedy for banks facing default would be to go to their lenders and ask they to take a (huge) haircut on their loans.  That’s what Greece ultimately did.  But the Cyprus banks are like giant cash machines.  They haven’t needed to borrow; they have almost no lenders to share the pain with.

The government could raise taxes–but it would have to be a whopper of an increase to make a dent in the funds needed.  And Cyprus’s government finances are  already in bad shape.

So the obvious (read:  only) source of bailout funds is uninsured customer deposits.

Hence, the plan to “tax” these deposits to get Cyprus’s share of the bailout money–offering equity in the restructured banks in compensation.  The way the tax is structured, it seems to hurt ordinary citizens and spare the oligarchs.

from the rest of the EU’s

In the overall scheme of the EU bank rescue, €17 billion is a trivial amount of money.  It’s something like a week’s interest expense on aggregate EU government debt.  But there’s a principle involved.  And there’s a related political issue.

In principle, a country that fails to supervise its banks and mishandles government finances shouldn’t simply be rescued without any contribution of its own.  Also, the biggest beneficiaries of any bailout would be what many regard as Russian criminals laundering their money through the Cyprus banks, with Nicosia complicit.  Understandably a hard sell throughout the EU–or anywhere else.

where to from here

The banks on Cyprus will be closed until some time next week, as the parties work toward a solution.  The main stumbling block sounds like it’s Nicosia’s desire to protect the golden goose of Russian money flow.

Stock market worries have been centered around the possibility of a run on banks in, say, Italy and Spain, if depositors in Cyprus lose part of their principal.  Part of the panic was sparked by economic “experts” who are recognizable names and who churned out the initial reports on late weekend’s bailout negotiations.  I think these pundits reacted to the headlines without knowing many of the facts.  It’s not that I’m an expert on Cyprus–I’m not.  But it’s pretty easy to detect when interviewees are talking through their hats.

The worst case solution for Cyprus would be that its major banks fail and the country is forced to leave the EU.  Very bad for Cyprus.  Almost no one else in the EU would notice.  Russian oligarchs wouldn’t be happy.

A run on other EU banks?  Unlikely, in my view.  The facts in the Cyprus case are very unusual, given the dubious character of its banks.  And the pressure on the EU not to simply throw money at the problem and make it go away is coming from ordinary citizens elsewhere in the EU who have their money on deposit locally.  They seem to see a big difference between their home country institutions and those on Cyprus.  I think they’ll continue to do so.

a wild card

Russia has previously made a bailout loan of €2.5 billion to Cyprus to prop up its banks.  Discussions are apparently underway between Moscow and Nicosia for more aid.  One plan being would have Cyprus grant Gazprom oil and gas exploration rights in return for, say, taking over one of the big insolvent Cyprus banks.

more about JCP

I’ve been thinking about Bill Ackman and JCP over the past few days, enough to have looked at the most recent financials for the company.  Why am I writing about this again?   You can usually a learn a lot from a situation where the wheels are starting to come off, and JCP’s 4Q12 financials give a good example of why the cash flow statement is an important document to study.

I haven’t (yet, at least, and I may never) done a real analysis and come up with an investment conclusion.  But I do have a reasonable hypothesis about what’s going on.  By way of its stores’ physical locations, JCP controls a lot of real estate, either through long-term lease or by owning it.  Given Mr. Ackman’s interest in real estate and his prior experience with Target, I imagine his plan has been to ultimately separate JCP into two parts, a real estate entity and a department store and thereby hopefully getting a much higher stock market valuation for each.  I’m sure he also saw some low-hanging operational fruit:  costs were too high, inventories were bloated, some non-essential assets could be sold.  Addressing these issues could raise a ton of cash.

In addition, the real estate value is connected in a strong way to the viability and profitability of JCP stores.  If the department store business is booming, the value of the real estate–in the sense of the ability to raise the rent–rises (and vice versa).  So a Ron Johnson-led makeover of JCP could have a big positive effect on both the value of the stores and the real estate on which they lie.

So much for the concept.  Where does JCP stand now?

Let’s take a look at the 4Q12 earnings report presentation:

recurring items

–during 2012, JCP cut SG&A (Sales, General & Administrative) expense by $603 million, even after  boosting marketing by $25 million and IT spending by $25 million.  That’s tremendous.

–at the same time, 2012’s same store sales comparisons fell by 25.2%.  Worse, comparisons deteriorated steadily as the year progressed, reaching -31.7% during 4Q12.  The number pf people going into JCP stores was off by 13% for the year, with, again, the low point of -17% happening during 4Q.  Conversion, meaning the percentage of people visiting the store who actually bought something, showed the same pattern:  -9% for the year, -10% for 4Q12.  To state the obvious, something went horribly wrong with department store operations.

–the cash flow statement (I’ve rearranged the order of the items JCP lists to give what I think is a more coherent story)…

Under GAAP (the accounting conventions used for financial reporting), JCP lost $985 million during 2012.

GAAP allows a company to reduce the reported loss by the extent it can shelter future profits from income tax (called deferred tax).  For JCP, this was $350 million.  Correcting for this, the pre-possible-future-tax-benefit loss was $1.335 billion.

Part of any company’s expenses are provisions for wear and tear on plant and equipment (the buildings, display counters and other fixtures).  This is called depreciation and isn’t cash out the door.  For JCP, this was $543 million.  Adding that back in gives a sense of whether the company took in money or had an outflow during the year.  In JCP’s case, the “cash flow” number is a loss of $792 million.

one-time items

JCP sold non-core assets during the year.  It wrote down others and took an employee benefit charge.  The gain on the sale and the charges pretty much offset one another, although the asset sales brought in $526 million in cash.

The company got rid of a lot of excess inventory, generating $575 million in cash in the process.  It also got better payment terms from suppliers that saved it, at least temporarily, from paying $140 million for merchandise.  Together, the two working capital actions generated $710 million in cash.  

The net of all this–and a couple of items I didn’t mention–is that operations pretty much broke even.

What’s important to note is that breakeven happened, in my view, only because the inventory and payables adjustments generated $710 million.  I doubt this can happen again in 2013.

investing/financing

JCP spent $810 million last year overhauling its stores and repaid $250 million in debt.  That’s an outflow of $1.060 billion.  It got $526 million in from asset sales.  There were a couple of other small items, leading to a net outflow of $$567 million from investing/financing.

the bottom line

For full-year 2012, JCP had a net outflow of cash of $577 million.  What jumps out at me, though, is that the figure is only this low because of asset sales and working capital adjustments totaling $1.236 billion.  Without them, the outflow is $1.8 billion+.

Of course, JCP would never have embarked on its aggressive store remake had it not figured the $1.236 billion would be available.  What it didn’t anticipate was the drain on cash from the collapse in sales.

where to from here?

In February, JCP announced it has negotiated an increase in its bank credit line to $1.85 billion.  I read this as as much a psychological event as a financial one–to reinforce the idea that JCP has plenty of money to carry out its transformation.

In the 4Q12 earnings call transcript I read, I was struck by the fact that many analysts wished the company good luck after they asked questions.  I can’t remember ever having seen this before.  Putting on my fortune-teller’s hat, I think analysts believe JCP is on the right track but are not yet 100% convinced that this story will have a happy ending.

As far as cash goes, the company now has about $800 million on the balance sheet.  It says it has non-core assets worth several hundred million dollars that it can sell.  And it has it bank credit line.  Absent a repeat of the horrible operating performance of 2012, that should be enough.

On the other hand, Vornado Realty Trust, an ally of Pershing Square Capital, recently sold 40% of its holding in JCP–hardly an act that inspires confidence.

For me, at this point JCP is an interesting case study and nothing more.  I have no special edge here.  I have no idea whether sales will begin to rebound quickly–in which case JCP shares would skyrocket–or not. And I don’t need to have an opinion.   So I’ll just watch from the sidelines.

Bill Ackman’s investment philosophy?

A couple of weeks ago, I heard a conference call held by noted hedge fund manager Bill Ackman (Pershing Square Capital) and broadcast over Bloomberg radio.  I didn’t listen to the entire call, but two things I heard have been rolling around in my mind since then.

a fifty year investment horizon…

1.  Mr. Ackman said that what distinguished him from other investors was that he takes a longer view than most in analyzing his potential investments.   His time horizon?   …the coming 50 years.  

Virtually every investment manager seeking clients will say that two factors differentiate him from rivals:  that he does more meticulous research; and that he has a longer investment horizon, which makes him more resistant to the periodic panics that beset the stock market.  So in one sense, Ackman’s assertion is right out of Marketing 101.  In addition, it certainly sets him apart from the crowd.  And it’s possible that he sincerely believes what he’s saying–although I think that, if so, there’s a wide disconnect between what he thinks he does and how he actually makes money.

But does a fifty-year time horizon make any sense?

I don’t think so.

For one thing, all the available evidence shows that professional securities analysts can’t accurately forecast company financials even one year ahead, let alone fifty.

…when everything is in flux

For another, let’s consider what the world of fifty years ago was like:

–there was no Internet.  So, no Google, no Amazon

–there were no cellphones

–there were no video games (Nintendo was making decks of playing cards); there was also almost no color TVs to play them on

–there were no personal computers, and not that many corporate mainframes, either

–there were no microwaves, no copiers, no fax machines (people used manual typewriters, carbon paper and the post office.  They warmed stuff on the stove)

–there was no Civil Rights Act.  Women and minority group members could do little more than menial labor

–air travel was in its infancy and the interstates were still being built. People traveled by boat and train.

I could go on, but the point is that life fifty years ago was mind-bogglingly different from life today.  It’s almost impossible for us to imagine what it must have been like, even though we have all the historical data, as well as access to people who experienced it first-hand.  It’s also hard to find companies that have survived during the entire period, and even more difficult to locate within that small group ones that haven’t had to change radically to do so.

How much harder, then, to project fifty years into the future, where we will likely continue to see equally surprising twists and turns?

Mr. Ackman’s reply, apparently, is that he invests in real estate, and buildings and land can easily stay around for a half-century.  I guess the argument is that the practice of entering into long-term leases means that real estate only responds slowly to changes in economic circumstances.  Still, it seems to me that real estate remains subject to the same forces of flux that anything else in the economy is.  Cities or states may move in and out of favor (think:  Detroit, the Motor City in 1960 vs. now), as do neighborhoods and sections of cities as circumstances change.  Real estate still needs to be traded, depending on changing economic fortunes.

2.  Mr. Ackman also described the first time he entered the Apple Store on Fifth Avenue in Manhattan (no date given, but the store opened in mid-2006.  Even with its recent swoon, AAPL shares are up 6x since then).  He was deeply impressed and knew there must be an investment idea based on his experience.

Others might have bought AAPL stock.

Not Mr. Ackman, who knew it ‘s impossible to predicts  fifty-year timeline  for the company.  Instead, Ackman decided to hire away fellow Harvard MBA, Ron Johnson, the head of the Apple Store division, and put him in charge of turning around J C Penney, where Pershing Square and allies had a controlling ownership position.

In moving from the store visit to hiring Johnson, Ackman must have made several other judgments that connect the dots:

–that Steve Jobs, one of the biggest micro-managers of all time, had no role in the location, design or layout of the Apple Stores.  It was all, or mostly, Johnson

–that the the fabulous success of the Apple Stores was due to Johnson, not to the quality of the Apple merchandise or the company’s truly immense marketing budget, and

–that the skills needed to run a chain of specialty boutiques selling very upscale consumer electronics products are the same ones needed to run a mid- to down-market clothing-oriented department store.

How has this worked out so far?

…a string of mammoth same-store sales declines by JCP, a large net loss and a decision by insider Vornado Realty Trust to dump 40% of its shares.  JCP stock has lost over half its market value since Mr. Johnson took over, a period when the S&P is up almost 30%.

I’m sure Mr. Ackman would tell you that you can’t judge a 50-year plan based on a mere 2% of that time.  Still, for me the whole conversation had a certain through-the-looking-glass air about it.