Five Main Points from Blue Nile's Q3

Nov.12.08 | About: Blue Nile, (NILE)

Blue Nile, Inc. (NASDAQ:NILE) held its third quarter 2008 conference call last week. I listened to the call and read the transcript at Seeking Alpha. We could dig into the facts and figures, but the reality is, I do not think the highly granular information matters right now.

The psyche of the consumer has been badly damaged, with October posting the lowest consumer confidence level on record. While our third quarter sales declined by 2.9% overall, published reports indicate that total Internet jewelry sales declined 11% year on year in the quarter. At Blue Nile we have seen our sales weaken in the past seven weeks, following the unprecedented events in the financial markets beginning in mid-September.

For the month of October, our sales were down 20% year on year. Given the events that have taken place in the global financial markets, consumers are understandably reluctant to spend. As the financial crisis has spread from the U.S. to other parts of the world, sales growth in our international business has slowed. Our international sales grew 53% year on year in the third quarter. Strong relative growth but down from our 179% growth rate last quarter.

The deteriorating global economy, coupled with the strengthening of the U.S. dollar, caused our international results to be more muted than those delivered in the first half of the year. With the buying power of currencies in our international markets declining roughly 20% versus the dollar, in combination with diamond prices increasing 20% year-over-year in dollar terms, consumers outside the U.S. saw extremely sharp increases in jewelry prices in Q3.

In addition, it’s important to note that the third quarter was the first full quarter in which we had anniversaried the May, 2007 introduction of our local currency websites for Canada and the UK. While we are experiencing some short term headwinds in our international business caused by global economic conditions and currency changes, we continue to be very enthusiastic about the future opportunity for our international business given the exceptional consumer value proposition that we offer.

Looking ahead, the economic climate remains extremely difficult. We are approaching the upcoming holiday season very cautiously. We will be sharp on price and value and will use this as an opportunity to enhance our competitive position. Current sales trends are very unclear. We don’t have a good picture as to how sales levels for the remainder of the quarter will compare to sales levels in the month of October.

While we would prefer to provide Q4 guidance, we have very little clarity as to how the economic environment will impact consumer spending patterns for the holiday season. For these reasons, we have decided that the prudent course is to not provide financial guidance for Q4.

What more do you need to know?

My view is quite simple. First, the company met its guidance and enjoyed free cash flow, both of which are positive. Second, the company's model scales extremely well. That is, when times are difficult, it does not have brick and mortar stores and other high fixed costs to support. When times are great, it can expand rapidly. Third, much of their competition is getting their brains bashed out during this difficult economic climate. Fourth, economic times are extremely challenging and, as a consequence, Blue Nile is unable to provide guidance for the fourth quarter. And fifth, uncertainty and nervousness are extremely high.

So where does this information leave us in terms of share valuation?

Any analyst that ascribes a specific value for the proper share price is nuts. Given that the company is unable to provide guidance and that uncertainty and nervous are rampant, precise share valuation is meaningless. My intuitive guess is that the low 20s is likely a buying opportunity and the high 20s is a selling opportunity. That is, buy the dips and sell the rips. I expect the stock market to remain volatile as we feel our way through this current mess. At times, buyers will feel confident and push share prices up. That is your opportunity to lighten up. And at other times, buyers will feel pessimistic and allow share prices to fall. That is your opportunity to purchase. If you like the overall business model, you can just sit back and enjoy the share price movement. When the economy shows signs of stabilizing (notice I did not say improvement, though that would be even better) and the share price is in the upper 30s or higher, then you can buy.

A natural question is, if the stock is going to rise eventually, why not buy now? Many people will not be able to stomach the volatility that we might encounter. If we hit a particularly rough patch, the price might even dip into the teens. For most people, the anxiety would be too great.

There are many beaten down stocks that will rebound sharply once the economy shows signs of stabilizing or improving. Look for companies with low debt and an ability to weather the economic storm. Keep track of these companies and when the economy begins to turn, you can seize your opportunity. In the meantime, keep your powder dry and wait.

Disclosure: I am long Blue Nile stock.