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 year's 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 and 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 disadvantage 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 Notes

Disclosure: Author does not have a position in NILE.

Comments

[sstro:]

Diamonds are pretty and sparkly and we have been ingrained to believe the bigger the diamond the more we love someone. Well the next time you look at that rock on someones finger try looking into it's past and see who's blood,sweet, tears and possibly the lose of their life made it possible. Diamonds might have sentimental value but you will rarely get back what you paid. Price fixing and slave labor is what gives diamonds their value.

2008 Dec 02 09:03 AM

[Chuck Steak:]

From the Blue Nile website:

The Blue Nile Position on Conflict Diamonds

Blue Nile, along with the global diamond industry, has a zero-tolerance policy toward conflict diamonds. Through measures such as the Kimberley Process, which tracks diamonds from mine to market, the industry in partnership with the United Nations, governments, and non-governmental organizations, polices diamond exports to prevent the trade of illegal diamonds.

At Blue Nile, we only purchase diamonds through the largest and most respected suppliers who, like us, proudly adhere to and enforce the standards established by the Kimberley Process. All Blue Nile diamonds are warrantied to be conflict free. If one of our suppliers was ever found to be in violation of that process, we would immediately sever that relationship. We will continue to support and promote any process that works to uphold legitimacy in the diamond trade.

Diamonds are mined throughout the world, including major mines in Australia, Africa, Russia and Canada. Diamonds are a major source of good in many African nations, employing and providing healthcare to thousands. For more information on this issue, please visit DiamondFacts.org.


Blue Nile supports the Kimberley process, which is an International process to track and certify diamonds. In April 2003, congress and President Bush passed a law adopting the Kimberley Process that requires all US diamond retailers to buy diamonds from manufacturers who have documentation warranting that the merchandise was obtained through legitimate channels. Today, the US Customs Service actively enforces the Kimberley Process requirements as diamonds enter American ports. For further information, please read the White House statement on the passage of this law.

On Dec 02 09:03 AM sstro wrote:

> Diamonds are pretty and sparkly and we have been ingrained to believe
> the bigger the diamond the more we love someone. Well the next time
> you look at that rock on someones finger try looking into it's past
> and see who's blood,sweet, tears and possibly the lose of their life
> made it possible. Diamonds might have sentimental value but you will
> rarely get back what you paid. Price fixing and slave labor is what
> gives diamonds their value.

2008 Dec 02 05:04 PM