Blue Nile Reports Modest Beat and Raise Quarter - 4Q Should Be Even Better

Caris & Company analyst Tim Boyd addresses clients on Blue Nile's (NILE) recent quarter results (3Q Earnings Call Transcript). His note follows:

Accelerating Unit Growth And Easy Comps Bode Well For Q4; Reiterate 2*/Above Average

Blue Nile reported a Modest Beat & Raise September quarter – revenues of $53.2MM and $0.11 in GAAP EPS came in above Street expectations for $51.1MM and $0.10, respectively. Revised 2006 guidance of $252MM in revenue and $0.73 in GAAP EPS also came in above consensus ($248MM and $0.72, respectively).

Y/Y unit growth accelerated; revenue growth decelerated slightly. Y/Y unit growth increased from 14% last quarter to 19% in September. Revenue growth was 27% vs. 29% as unit growth outpaced the growth in ASPs. We believe that the acceleration in unit growth is a key positive heading into the all-important holiday shopping season – especially given the easy comps vs. a disappointing 4Q05.

Margin pressure continues, but comps getting easier. NILE’s gross margin fell 30 bps Q/Q as the company maintained its aggressive pricing strategy in the face of higher raw material costs. The EBITDA margin also fell Q/Q, the product of lower gross margins and higher marketing costs. As NILE gets set to anniversary its more aggressive pricing strategy and increased marketing spend, however, we see the potential for margin expansion throughout 2007.

Continued high level of FCF conversion. NILE continues to boast FCF/EBITDA conversion numbers that are, to the best of our knowledge, unmatched in the Internet sector. For the TTM period ending in September, NILE converted 135% of its EBITDA to FCF. We continue to believe that the market is underestimating the impact that this will have on NILE’s bottom line growth, especially over the longer term.

Increased focus on international growth. NILE’s international sites contributed $2.2M in revenues in 3Q06, up 160% Y/Y. On the conference call, management noted that it will begin to focus more on its international efforts in 2007, with an emphasis on its U.K. and Canadian websites. Given the relative lack of competition in these and other key international markets, we continue to see NILE’s non-U.S. opportunities as laden with much low-hanging fruit.

Shares off about 5%. Yes, NILE’s 3Q06 results and guidance were clearly better than Street expectations. But Internet stocks that are up 50% intra-quarter and trade at 50x FTM earnings rarely trade up on anything other than blow-out numbers. This is fine by us, however: we like owning the shares throughout 4Q06 and see any sustained weakness (which is most likely the result of some healthy profit taking) as a buying opportunity. A massive 30% short base will likely continue to provide support to the shares.

We are adjusting our 2006, 2007 and 2008 estimates as follows:

We are maintaining our 12-month target valuation of $40. $40 is 30x our 2008 pro forma EPS estimate and 18x our 2008 EBITDA-per-share estimate.

NILE 1-yr chart: