Real Client Managed Portfolio Investment Recommendation

REAL CLIENT MANAGED PORTFOLIO INVESTMENT RECOMMENDATION

TO: Real Client Managed Portfolio, Spring 2012

FROM: Te-Chi Kuo (William), Chen-Yuan Huang, Yu-Te Hung (Ted),

Min-Min Chen, Po-Chieh Shih

DATE: April 24, 2012

OBJECT: Tiffany & Co. (NYSE: TIF)

RECOMMENDATION:Put on watch list

Macroeconomics and Industry Outlook:

Although North America is still the biggest economic entity, East Asia Pacific and Latin America have been growing very fast in the recent years. Moreover, the U.S. household earnings over $100,000, after the financial crisis, will averagely grow 2% in the next five years, the U.S. Consumer Sentiment Index has recovered, and the unemployment rate is projected to decline in the next eight years, so we are optimistic toward the future economy. However, the spike of diamond and gold price could be a concern, which might dramatically increase cost to the firms in the industry of jewelry retailer.The industry’s revenue mainly comes from diamond and gold jewelry, and customers are mainly households in the first and the second high quartile. Purchases and wages account for the quite great proportion in the structure of industry’s costs. Overall, in the industry the competition is high but fragmented,leaving a high ease of entry barrier.

Business:

Tiffany, established in 1837, is a manufacturer and retailer of jewelry, which accounted for more than 90% of revenue in 2011. Tiffany operates through its 247 retail stores worldwide, and the company also reaches customers through internet, business-to business sales, and wholesale distribution. In 2011, total sales increased 18% to $3.8 billion because the growth from all regions.Americas accounted for 50% of total net sales, and Asia-Pacific, the fastest growing area, represented 21%. 17% of revenues were from japan while the rest of them were from Europe.With strong momentum in Asia and rebound in Americas, the management plans to open 24 new stores around the world in 2012 to achieve higher growth. In addition, the management plans to improve its online sales both in Asia-Pacific and Europe.The downside risk is the climbing metal price which decreases profit margin of company. However, the company increases its retail price and improves manufacturing efficiencies to offset the effect of higher product costs.

Financial Analysis:

Among other competitors, Tiffany has the best of all financial metrics, including liquidity, asset turnover and profitabilityratio. The current ratio increased to 4.61 from 3.15 during 5 years. Even the inventory turnover decreased from 1.03 in 2007 to 0.72 in 2011, the company kept the operating cycle constant through increasingaccount receivable and reducing account payable turnover. The gross margin is up slightly, from 56.41% in 2007 to 59.05% in 2011, to reflect its expansion in diamond business. On the other hand, operating margin tumbled to 13.85% in 2008 because of its restructure plan. However, operating margin jumped to 19.45% in 2011.Definitely, the recession of 2008 impacted the ROE ratio substantially, the lowest level of five years, but the company tried to remain relative stable by financing new debts. In 2011, ROE ratio recovered to 18.70%, up 4.08% from 14.62% in 2008.

Valuation with Multiples of Public Comparable and Discounted Cash Flows:

Since there are no single merchant in this industry own more than 10% of the market, we use the largest player Signet Jewelers Ltd. (SIG) along with Coach, Inc.(COH)and Ralph Lauren Corp. (RL) as comparable. Coach and Ralph Lauren are representing the luxury product like Tiffany. We then used P/E, EV/EBITDA, EV/Revenue and P/BV multiples to calculate the value per share of Tiffany.On the other hand, the discount rate we use is 10.30%, which includes 50% of weighted-average cost of capital and 50% of return on equity investment. The projection is based on Tiffany’s past earning performance and the IBISWorld Survey.

Recommendation:

The fair values using the multiple method range from $67.98 to $75.07. The fair values using DCF model range from $48.23 to $66.81. As of April 23rd, 2012, the price was $67.00. As a result, we put Tiffany into our watch list unless the price goes down below $45.