Tiffany’s first-quarter earnings handily beat our estimate by $0.21 and the Street’s by $0.19 ($0.97, versus our $0.76 and the Street’s $0.78) on better-than-expected top-line growth, primarily related to the pull-forward of sales in Japan ahead of the consumption tax increase, as well as stronger gross margin. The 2014 outlook was raised $0.10, which largely reflects the magnitude of the first-quarter beat offset by reduced expectations for the second quarter attributed to the downslope of Japan and increased marketing expenses.

Overall, Tiffany delivered a solid quarter against difficult headwinds, even excluding the one-time demand benefit from Japan. However, the stock trades at 23 times the high end of guidance (14% earnings growth), and while we see upside potential for the remainder of the year as product and marketing initiatives take hold, we believe that this is largely reflected in the valuation and are not inclined to chase at these levels.

We are encouraged by improvement in the fashion jewelry category (highlighted Atlas), with strength from gold and an improvement in silver, narrowing the gap in the rate of sales relative to other categories. There is still more work to be done in this category, but the influence of Francesca Amfitheatrof should be visible with an upcoming introduction of new product in September.

Japan delivered a 30% comp, largely driven by an increase in demand in March ahead of the April 1 consumption tax increase. Although results were largely predicated on a one-time demand increase, Japan’s two-year trend was +51%, versus +19% overall, with no change to annual projections from this region. Gross margin increased 200 basis points, driven by favorable product costs, price increases across all categories and regions, sales leverage on fixed costs, and the sales effect from Japan (region has the highest contribution margin). In addition, given the improvement in fashion jewelry, this category had minimal effect on gross margin.

Analysts believe that the company’s long-term move to reposition the business with greater fashion-orientation and higher-end merchandise, and away from a gift-giving destination, is sound but will take time. The stock is trading at 23 times our revised estimate, versus our revised 14% EPS growth. That yields a PEG ratio of 1.7 times, versus 2013 of 1.5 times and its five-year average of 1.3 times. Thus, while our long‐term view on Tiffany remains favorable, we believe the shares already anticipate significant earnings upside potential, and we are not inclined to chase the stock at these levels, despite our positive view of the brand and its long-term growth opportunity.

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