Macro Headwinds Mean Blue Nile Could Slide Even Lower

| About: Blue Nile, (NILE)

Shareholders of Internet jewelry retailer Blue Nile (NASDAQ:NILE) should be very concerned that Tiffany & Co. (NYSE:TIF) posted a 21% decline in holiday sales due to a pullback in consumer spending across all "categories" and "price points" and that management expects the deteriorating conditions to persist throughout 2009.

The shares of Blue Nile have fallen 70% from its 52-week high and further downside to the share price is likely as more and more consumers pall back on high ASP and discretionary items – two core tenets of Blue Nile's direct-to-consumer model. Compounding the pressures on revenue is that management has less flexibility to cut expenses further and that could lead to huge profit declines.

Traffic to the website has plummeted in the past few months and is likely to get worse. While diamond and other commodity prices are coming down, demand for diamonds has essentially stalled due to layoffs, low to no wage increases, low to no bonuses at most companies, declining home values which makes tapping equity lines difficult, and reduction in credit card balances which reduces purchasing power. In addition, credit card application approvals are down significantly due to tighter credit standards.

My guess is that men will be dropping by their local jewelry stores to cut cash deals, so to speak, in order to get their engagement rings. Thus, in this environment, we are likely to see a share shift back to traditional jewelers.

Even with the sharp share price decline, the shares still trade at an unusually high multiple of 23x 2009 GAAP earnings and with a PEG of 1.3x, although I believe the PEG should be higher because analysts are overestimating the growth rate of 18%.

For a stock facing such headwinds, the shares should trade at a single digit P/E, which would take the share price way into the single digits as estimates are ratcheted down. The company is probably looking at flat EPS growth in '09 and flat growth again in '10 at best. So what multiple do you apply to those earnings? Even if you are being generous and apply a 10x multiple to those earnings you are getting a $10 stock price. The shares are trading at near $20. Thus investors should look the other way on this stock as their investment could be cut in half.