the curious case of Chow Tai Fook Jewellery (HK:1929)–Tiffany (TIF), too

…toss in Wynn Macau (HK: 1128), as well.

Chow Tai Fook

Chow Tai Fook is a Hong Kong-based jeweler that IPOed there last December.  The company’s main business is chuk kam (24 karat) gold objects, the stuff that’s sold by weight, not market up by 100% (or more) over direct costs.  It’s not only decoration, but you can bury it in the back yard if you’re wary of banks.  And you can wear your wealth to work, in case you find out you have to flee the country right away.   (You wouldn’t chuckle if you’d lived through 1940-1960s China.)

The firm has expanded from the SAR into the mainland, and from chuk nam to high-end “fine” jewelry designed to flaunt your wealth, not hide/preserve it.  In recent years, the latter has become an increasing percentage of Chinese jewelry consumption.

a December 2011 IPO

The IPO was anything but a rousing success.  The stock was priced at HK$15, to raise US$ 2 billion.  But it came to market just as Beijing’s efforts to slow down the domestic economy were causing affluent mainlanders to cut back consumption.

The issue closed on day one at $13.80–and headed south from there.  It finally bottomed some months ago at HK$8.40.  Ouch!!

…so, what’s curious?

Here’s the thing.

The economic evidence over the past few months is that China is slowing further, despite signals from Beijing of its change to a more expansive government economic policy.

The EU is a mess.

US industry is slowing down and the “fiscal cliff” is getting closer.  Burberry and Tiffany have revised down earnings, in large part because of disappointing sales in China.  So too have tech companies like Intel.

Nevertheless,

since July 27th,

Chow Tai Fook share are up by 26.5%–vs. the Hang Seng index up 6.9%

BTW, Wynn Macau shares are up by 30.0% over the same time span

TIF began rising a little earlier in the month, but has gained almost 25% from its low–compared with about an 8% rise in the S&P 500.

why this good performance?

It’s a little like the case of Benjamin Button, whose body went through the opposite of what nature usually does.

Possibilities:

–If this were ten or fifteen years ago, I’d say investors are seeing through current weakness and beginning to discount in advance the recovery that the government policy change will likely bring.

But reacting to government cues is not the winning strategy it once was.  That’s partly because the economic problems the world faces today are more structural than cyclical.  Also, the rise of hedge funds has reoriented markets sharply in the direction of short-term trading than they have ever been.

Besides, luxury goods makers like Hermes and LVMH haven’t experienced the same stock price lifts.

–new bets on China?  But, if so, why no response from Hermes, LVMH or Coach?  Also, why would UK-US (lower-end) jeweler Signet be having better stock performance than the other three?

–influence of EU investors?  My impression has been that a lot of the damage to Hong Kong stocks during the middle months of 2012 was due to panicky selling by EU-based investors.  The clear new bullishness emanating from Europe may be resulting in portfolio managers plowing back into Asia.  That might explain why 1929 or 1128 are doing well.  But why TIF?  …or why SIG and not LVMH?

–minimizing exposure to the EU?  For aesthetic reasons, I like this better than “bets on China,” because it’s a more sophisticated wager–one based on avoiding a bad experience rather than necessarily having a good one.  Still, why TIF?

You could build a “synthetic” TIF-ex-the-EU, by combining SIG +1929.  Not a perfect replacement, but if the main idea is to avoid the EU probably an acceptable one.

my take

I’m sure there’s a method to the apparent madness.  At this point, however, I don’t know what it is.

I could say that professional investors are shifting their portfolios toward secular growth areas (as opposed to more cyclical ones) where they see profit growth will be the strongest next year.  Yes, that’s true, but it’s what most managers always do.  So it’s flirting with tautology.  The crucial question is why jewelry and casino gambling?

Is there something special about these two areas?  …or is there something awful about everything else?

One thing I am convinced of is that solving the puzzle correctly can bring investing rewards.

I own 1128 and 1929 but none of the rest of the names I’ve mentioned here.  I have no burning desire to add to any–although if I can figure out what’s going on I might develop one.

If someone were forcing me to buy  one of the names, it would probably be 1929.  The fact that it’s the most speculative of the stocks is not a coincidence.  I should knock off the caffeine instead.

Tiffany’s 2Q12: interesting stock market reaction

the report

Prior to the New York open on August 27th, TIF announced its 2Q12 (ended July 31st) results.  Earnings were up by 2%, year on year, at $92 million.  Eps were $.72/share, also up 2% yoy.  Ex non-recurring items, which depressed 2Q11 eps by $.16, the yoy earnings comparison was negative–down 17%.

Quarterly sales came in at $887 million, also a 2% yoy advance.   Negative currency effects–a 2% decline of Asia-Pacific currencies against the dollar, and a 9% fall of European, reduced that figure from what would have been a 3% constant currency gain.

EPS were a penny below the Wall Street consensus of $.73.

Although TIF said its 2Q12 performance met its expectations, it lowered full-year guidance for the seond time in two quarters.  The new full-year eps range is $3.55-$3.70 vs. guidance of $3.70-$3.80 announced with 1Q12 results.

The stock?  It rose by 7%+ on this news.

the details

the Americas 

Same store sales were down 5% yoy, and minus 9% in the flagship store in NYC.  All the weakness came from domestic customers.  Sales to foreign tourists were flat, with a falloff in EU buying offset by increases in Asian visitor purchases.

Florida, Texas, and Guam were notable areas of strength.

Asia-Pacific

Same store sales were down by 7%, two of those percentage points due to currency weakness.  Slight price increases, lower unit volume.

Japan

12% same store sales growth in local currency, offset somewhat by 2% yen weakness vs. the US dollar.  Continuing recovery from Fukushima-related weakness.

Europe

2% same store sales growth was more than erased by 9% currency weakness.  Continental Europe was stronger than the UK.  Foreign tourist buying made the figures look better than they would have been from local customers alone.

the balance sheet

It’s not something I’ve commented on before.  But the yoy change is remarkable.

During 2Q12, TIF raised $250 million in long-term debt, $60 million of which went to retire maturing borrowings.

Total debt now stands at $940 million, cash at $367 million.  A year ago, the figures were $694 million and $565 million.  Put another way, the company has gone from net debt of $129 million to net debt of $573 million, a $444 million negative swing, over the past twelve months.

The figure means TIF invested close to half a billion dollars in excess of funds generated by operations in business expansion.  Most seems to me to have been used to build inventories, with a modest amount for expanding the store network.

market reaction has been positive…

…even though there’s evidence of a continuing slowdown in high-end jewelry buying in both the US and China.  Nevetheless, TIF shares appear to have bottomed around $50 in June.  They’ve been rising steadily–and outperforming the overall market–since.

my take

TIF shares are up over 20% during July and August, despite the weak business outlook.  I hadn’t expected this.  I’d thought the stock would likely languish until there were clear signs of a pickup among either Asian or US customers.

Yes, the company is very well-managed.  The newly raised debt gives it a larger cash cushion, in case its business remains in the doldrums for an extended period.  It seems clear to me that TIF has, prudently, shifted out of rapid expansion mode and into a more defensive cash generation stance.  If this turns out to be the last downward earnings revision, the stock was inexpensive at $50.

Still, I think it’s interesting that the market is willing to pay for an anticipated recovery in TIF’s business so far in advance.  It conveys to me the suggestion of an underlying bullishness among market participants that contrasts sharply with bearish media sentiment.

As for TIF shares themselves, I’d prefer to wait either for a price in the mid-$50s or the 3Q12 earnings announcement rather than buy here/now.

trying to move downmarket is tough–Apple vs.Tiffany and Superscope (who?!?)

going downmarket:  the Superscope example

When I got my first job as a securities analyst, rookies were assigned coverage of companies no one else wanted.  So I got a bunch of firms with bad managements, poor operating procedures and/or failing strategic concepts.  I was happy to be employed, but otherwise I was less than thrilled.  But a comment by J.L. Austin turned out to be true.  I did learn a lot more about how business works by observing things going wrong than I ever would have by watching uniformly smooth sailing.

One of my first companies was called Superscope.  The company’s claim to fame was that it discovered Sony “operating out of a quonset hut” in Japan in the late 1950s.  It obtained from the then fledgling electronics giant an exclusive license to distribute Sony’s innovative line of tape recorders in the US.  The license made Superscope a fortune.

In the mid-1960s, Superscope bought Marantz which was then an ultra high-end maker of stereo systems.

In the 1970s, preparing for the reversion of the tape recorder license to Sony, Superscope decided it would replace the lost income by launching a line of inexpensive, mass-market consumer electronics devices.   It thought it would increase the odds of the line’s success by branding its offerings as “Superscope by Marantz,” thus grafting onto its boomboxes the Marantz brand qualities of exclusivity, high quality and dependability.

As the successor company website comments, “Naturally enough, the two brands became intertwined in consumers’ minds.”

Translating this marketing-speak into ordinary language, the move completely destroyed the Marantz brand.

The appearance of low-fidelity $150 stereo systems under the Marantz name shattered the image of high quality and exclusivity that had motivated audiophiles to pay many thousands of dollars for the original Marantz systems.   As I recall, it didn’t help either that the  boomboxes were very far from best-of-their-breed.

the Apple smartphone dilemma

Why this trip down memory lane?

It’s because Apple faces a somewhat similar problem with its smartphone business, which produces half the company’s profits.

As some Wall Street analysts have been point out for over a year, the market for $600+ smartphones in wealthy countries is approaching saturation.  The as yet untapped markets are in emerging nations like China or India, where older “feature” or “flip” phones still predominate.  But if your annual family income is, say, $5000, how many $600+ smartphones can you afford.  Answer:  zero.

That’s why many phone makers are collaborating with local wireless companies to develop and market smartphones that cost $100 or less.

How can Apple compete?  Should Apple try to compete in this market segment?  The risk is that it repeats the experience of Superscope.

going upmarket is easier

Oddly, experience says it’s much easier to go up-market, although often a company will create a new, upscale brand name.  That’s what the Japanese auto companies did, for example.  Nokia, too, with its Vertu brand–which consists of making ordinary phones into jewelry with precious metals and gems.

Tiffany magic

How does Tiffany come into the conversation?  It’s the only company I know that is able to be successful both at the high end of its market (jewelry at $10,000+) and the low end (key chains and trinkets for $100-).  I don’t know how the firm accomplishes it.  I offer the example only to say that the move downmarket can be done.

TIF’s 1Q12: surprising slowdown by US customers

the report

TIF reported 1Q12 (ended April 30th) results prior to the opening of equity trading in New York yesterday morning.

Revenues were up 8% year on year, at $819.2 million.  The company earned $.64 a share for the three months, down a bit less than 5% from  results–but substantially below the Wall Street consensus of $.69.

Tif also lowered its full-year guidance by $.25 a share, to a range of $3.70-$3.80.  Worldwide sales are now expected to grow at a 7%-8% rate, down from the prior expectation of +10%.  Eps comparisons will likely be negative in 2Q12 and 3Q12.

The stock dropped sharply on the news.

As I’m writing this on Friday morning, TIF shares are somewhat lower again, in a choppy but flattish market.

the details

sales

Americas           up 3% at $386 million

Asia Pacific         up 17% at $195 million

Japan          up 15% at $142 million

Europe     up 3% at $88 million.

Business was much better than I had expected in Japan.  Analysis is complicated by the fact of the Fukushima nuclear disaster in mid-March 2011.  Still, same store sales growth is up more than 10% from two years ago, in a land that had been turning decidedly cool toward luxury goods.

I think any gain in Europe, now the epicenter of world economic woes, is just short of miraculous.

Asia Pacific performed as expected–no better, no worse.  The company says Chinese business has cooled a bit from the torrid pace of last year.  I don’t consider this a worry.  But it does suggest that Asia won’t be a source of significant upside surprise for a while.

It’s the Americas, and specifically the US, where the falloff versus expectations lies.  Sales to foreign tourists are up, with weakness in European buying more than offset by a step-up in purchases by Asian visitors.  So it looks like the problem is with sales in the US to Americans.

TIF pointed out in its conference call that the softness:

–occurred in April

–is not focussed in any one region of the country (so it isn’t just laid-off NY bankers), and

–is consistent with MasterCard data for high-end jewelry in general (so it isn’t a Tiffany-specific issue).

my thoughts

Some portion of the poor US performance may be attributed to a later date for Mother’s Day this year.  But everyone who has access to a calendar already knew that.  Certainly management had factored this into its earlier guidance.

The downward revision comes after TIF has seen Mother’s Day sales.  I think this means that–unlike the case with more mass-market jewelers like Signet–Mother’s Day didn’t counteract April weakness for TIF.  It confirmed the slowdown.

Elsa Peretti

TIF has an exclusive license to sell Elsa Peretti jewelry, which makes up about 10% of company revenues.

The company filed an 8-K with the SEC on May 23rd in which it says that Ms. Peretti, 72, wants to retire and to sell her brand name and designs.  Negotiations between her and TIF are now in progress.  The Peretti intellectual property should have more value to TIF than to anyone else, so in a completely rational world TIF would end up obtaining it.  Earnings would be affected by, say, +/- 7%-8%, depending on whether negotiations result in purchase or not.

the stock

A short while ago, I sold the last of the TIF I held while I was doing a portfolio housecleaning.  My position was small and–as I’ve written elsewhere–I think the stock market is moving toward playing recovery of the average American rather than the continuing prosperity of the affluent.

I don’t feel a huge urge to buy back the stock I sold.

On the other hand, the stock looks cheap to me at 15x earnings.

15x was the place where I became interested in the stock–which I had owned in my portfolios, off and on, for many years–during the bounceback from Great Recession lows.  There’s always the possibility that the company could be acquired by a luxury goods conglomerate or a sovereign wealth fund.  We also know TIF management, which should know the value of the firm better than anyone else, has been buying the stock at above $60 a share.

I guess I’d like to watch the price for a while-and possibly get a better understanding of the current dynamics of the US customer.

 

 

 

 

TIF’s 4Q11: supply your own adjective

the results

Just before the open on Tuesday March 18th, TIF reported earnings results for fiscal 4Q11 (TIF’s accounting year ends in January of the following calendar year). Sales came in at $1.19 billion, up 8% year on year. Profits were $178 million, or $1.39 per share, a drop of 2% from 2010.

For the full year, sales were $3.64 billion, a yoy advance of 18%. Eps were $3.60, or + 23% yoy.

In a lackluster market, the stock was up more than 6% on the news.

details

Sales for 4Q in the Americas were up 5% yoy; in Asia-Pacific they were up 19%, up 13% in Japan and 3% in Europe.

In early January, TIF had warned that its business had slowed significantly from the torrid pace of the first three quarters of 2011 (see my post). Overall, the results TIF actually reported were slightly better than it signaled at that time. Thanks to a small rebound in January, sales in the Americas were 1 percentage point higher than TIF was figuring, and Europe—of all places—was 2% better.  No change in trend elsewhere.

It doesn’t make a whole lot of difference, but 4Q11 eps would probably have been at least flat with 4Q10 and maybe up a penny, were it not for a year-end upward adjustment of the company’s tax rate. Without going into all the details,  a greater proportion of TIF’s sales than anticipated came from high-tax areas like the US and EU. Put another way, the tax rate adjustment is a consequence of the fact that sales in Asia-Pacific fell off more in 4Q11 than the rest of the world did.

TIF also gave its initial guidance for fiscal 2012—sales growth of 10%, earnings per share growth of 10%-13%–resulting in eps of about $4 for the year. The company thinks the bulk of the advance will come in 4Q12.

During the first half of 1Q12, results are tracking in line with TIF’s expectations.

During the quarter TIF spent $35 million buying back stock, at an average price of $67.26. That’s about 30% less than TIF averaged over the first nine months of the year. To me, it looks like all the buying came before the company’s profit warning. If so, I certainly can’t be too critical since I had no enthusiasm for buying, either.

Arguably, continuing to buy below $60 at the same time the company knew its sales shortfall would mean a lot of money tied up in unsold inventory would be too risky. But it certainly implies to me that TIF is not shrugging off the current sales slowdown as something that will soon be behind it.

my thoughts

TIF’s 4Q11 has played out pretty much as I thought it would in January. The only new news from the company announcement is that the situation appears to be stabilizing at the lower rate of sales growth TIF experienced in 4Q11. All in all, I don’t get the market reaction of aggressively bidding up the stock on this information.

Contrary to what I would have expected, TIF shares have also recovered all they had lost vs.the S&P after their January swoon.  And that’s before this week’s earnings report.

The stock now trades at around 18x this year’s earnings. That’s not wildly expensive for a company like TIF. But it’s not cheap, either, especially with perhaps three quarters of lackluster earnings comparisons in prospect.

There’s certainly a risk that my incorrectly lukewarm attitude to the stock at $59 will color my opinion now. Nonetheless, I’m happier on the sidelines now than buying. And I’ve got to at least consider the idea of selling some of what I own into any strength.