Tiffany Stock Upgraded on Improving Luxury Trends

Richemont's better-than-expected third-quarter sales indicate that demand trends for luxury goods are stabilizing, a positive for Tiffany & Co.'s (TIF) top line, Wells Fargo analysts said in a note today. 

The firm upgraded Tiffany shares to "market perform" from "underperform," sending the stock about 2.5% higher to $82.57 in early Friday afternoon trading. 

The global luxury retail market appears to have bottomed in the first half of 2016, with improvement in most geographies and categories in the second half of the year, Wells Fargo analysts noted.

Notably, Swiss jeweler and watchmaker Richemont posted a 5% increase in third quarter sales on Thursday, driving shares of New York City-based Tiffany and European luxury brands including Prada (PRDSY) , Luxottica (LUX) and Swatch (SWGAY) to close Thursday's trading session in positive territory.

"While it remains to be seen how robust the recovery in the global luxury market will be, at the very least the sharp declines that weighed on late-2015/early-2016 have moderated and the outlook for luxury is more favorable than it's been in at least 18-24 months," Wells Fargo analysts wrote today.

Tiffany could also benefit from House Speaker Paul Ryan's proposed border tax adjustment.

The retailer generates a high percentage of sales outside of the U.S., imports a small percent of cost of goods sold, is a high-margin business, has a relatively high tax rate and has consistently demonstrated pricing power, according to Wells Fargo.

Tiffany is expected to report December sales before Tuesday's market open. 

A positive figure would set the retailer apart from many of its peers. Since the beginning of this year, 19 out of 25 retailers' sales updates have been negative, according to Wells Fargo. 

"Thus, while TIF is gaining visibility into their demand trends, the rest of the group is operating in a far choppier environment (particularly those concepts that are highly correlated with broader mall traffic trends)," the analysts said. "With investor sentiment surrounding retail worsening by the day, we find it difficult to envision TIF shares underperforming any longer."

Risks to Tiffany's business include a traffic disruption at its flagship store, given high security at next-door neighbor Trump Tower, and dwindling tailwinds from commodity deflation.

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