Categorized | Short Ideas

Blue Nile – Diamonds are NOT Forever…


Bargain hunters may be tempted to take a look at Blue Nile, Inc. (NILE) which is down roughly 75% from last years high.  After all, the company has no debt and posted third quarter profits as opposed to many retailers which showed losses.  The company actually saw sales come in near the same levels as last year, which has some bulls optimistic that stability will remain with this diamond retailer.  ZachStocks’ readers will note previous cautionary articles on Blue Nile, and have hopefully sidestepped the carnage.

Looking more closely at the company’s earnings release, it is clear that trends are souring – and quickly.  In a press release from early November, management stated that the holiday season would be challenging.  October sales were down 20% from last year, and that doesn’t account for the typical holiday rush that will likely be inferior to 2007 levels.  In a sign of the times, Blue Nile has for the first time in its public history, declined to offer guidance for the coming quarter.  Diane Irvine, CEO, stated that the environment was simply too challenging to give investors a reasonable expectation for sales during the third quarter.

In an interview with Investors Business Daily, Ms. Irvine stated that the primary challenge is a lack of available credit for the company’s customers.  The bulk of NILE’s sales comes through credit card purchases.  That is certainly a difficult obstacle considering the fact that most card issuers are pulling back limits on outstanding cards, and declining to issue new cards to potential buyers.  Blue Nile actually offers third party financing on its website, but has seen approval rates drop due to tighter credit standards.

The typical NILE customer is a 25 to 35 year old male purchasing an engagement ring.  Unfortunately, this is one of the hardest hit demographic categories.  At this time the typical buyer is opting for a smaller diamond, a less sophisticated band, and in general, a lower priced item.  Bullish investors have long argued that the jewelry business caters to the wealthy affluent, and should be relatively immune to an economic downtrend.  But since NILE focuses on the lower-end engagement type jewelry, the company’s customers are actually very sensitive to economic cycles.

As I write, the stock is trading in the low 20’s with 2009 earnings expected at $0.90 per share.  Now, I understand that these expectations could change significantly over the next year, but a multiple above 20 seems unrealistically optimistic in my opinion.  The company should survive as an ongoing business due to its low cost structure and sound financial footing.  However, earnings will not likely rebound sharply as consumers will continue to be careful with spending even once the economic cycle begins to turn.

Some may expect inflation to help the jewelry business out as inventories will likely rise as the purchasing power of the dollar declines.  However, RBC had an excellent research report which among other issues, pointed out that inflation would actually dis-advantage NILE.  The reason is that the company holds a relatively low level of inventory so inflation would increase costs just about as fast as it increases sales prices.  Margins would likely remain stable, thus offering little help to a troubled retailer.

Despite the lower stock price, I would continue to urge caution and steer investment capital away from this name.  There may be a period where the value in NILE shares becomes compelling.  But at well over 20 times expected earnings, I believe the risk far outweighs the potential gain.

nile-chart-3.JPG

NILE Notes
FD: Author does not have a position in NILE

Additional Reading:
Barrons: Blue Nile – Estimates Cut
WSJ: US Slowdown Impacts India’s Diamond Capital

Blue Nile – Diamonds are NOT Forever… Womens Shoes

4 Comments For This Post

  1. BorisB Says:

    down 80% and still no upside path for the longs. amazon.com, costco, and walmart might be positioned to take over big pieces of the “discount” diamond-ring niche opportunity.

  2. Zachary Scheidt Says:

    Boris,

    I think you could be right. There are certainly strong competitors on the scene both in traditional stores as well as on-line. The more important force today is the lack of consumer credit for purchases like this.

    I’m not a fan of going into debt to buy jewelry but the fact remains that this is how most engagement rings are bought. Lack of credit is a serious issue in this business model.

    As always, thanks for the comment!
    Zach

  3. Sara Jones Says:

    A class action suit has been filed for failure to dislose treatments to gemstones. If you are interested in participating please contact me.

    Sara Jones
    bluenileclassaction@hotmail.com

  4. Virgil Says:

    I think Blue Nile is positioned better than almost any other diamond or jewelry retailer. They will grow market share as more than the 25-35 male demo is prompted to look for discounts.
    As they grow their share in a rough env. others will go out of buisness. As the econ turns, they will keep their loyal customers as most internet retailers have due to conv, ease of use and price.
    Short term the stock is being held down by short sellers and lack of buyers in general. As the market turns, look for NILE to attract a lot of attention for those looking for growth with min risk (strong bal sheet and rezillant biz model)

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