Shares of Blue Nile Inc. (NILE) have broken decidedly lower after the company issued its first quarter earnings report last week. Sure, the overall market was weak and helped add emphasis to the decline, but the outlook for this speculative retail stock continues to be anything but shiny. We continue to hold a significant short position in the ZachStocks Newsletter portfolio as the outlook does not appear to justify the price.
First quarter earnings came in roughly in-line with expectations at $0.16 per share. This was good for a 23% increase over the earnings figure for last year. Revenue narrowly missed expectations with sales coming in at $347.5 million as opposed to expectations at $348.9 million. The difference is minuscule, but the failure of NILE to beat expectations is what will catch investors eye and likely cause concern.
Similarly, the guidance issued by management came in roughly in-line with expectations as management expects to generate $1.01 in earnings this year. At Friday’s close – even after the sharp decline – NILE’s shares were still trading at nearly 50 times the expected earnings for this year. It appears investors are still expecting great things out of the online jeweler.
Despite the perception of the jewelry industry collecting thick profit margins, Blue Nile appears to make a very small profit relative to its sales levels. While the company selectively displays a 21.3% gross profit margin for the first quarter, the overhead expenses significantly reduce profits. Total net income was $2.4 million compared to sales of 74.1 million – so investors realize just a 3.2% profit margin on the company’s sales.
Given the high multiple on the stock, I would expect a much larger return on company revenue. Despite the luxury image, Blue Nile is basically a commodity retailer – buying diamonds and other jewelry, and turning it around at a small increase in price. And without a showroom and pushy sales staff that is usually present in brick and mortar distribution networks, NILE can only compete on a price basis. Basic economics say that this type of business must focus on volume instead of price – and sketchy sales growth over the last two years, the high stock multiple seems unjustified.
There are certainly some positive issues that could eventually help to support the stock. NILE is sitting on an ample supply of cash with virtually no debt. The company finished the first quarter with $47.2 million in cash. Management has been using the cash to repurchase stock – and over the first quarter the company repurchased 292,100 shares at an average price of $52.04.
Usually, I would be a fan of a company using cash to repurchase shares. The net result is a lower share count which can be accretive to investors. But with the company also paying $50 for every dollar expected in earnings this year, the purchase price appears steep even for a company buyback.
Today’s broad rally in the market may be a gift for traders interested in shorting NILE but those who missed the break last week. As I write, shares are up 2.5% on very light volume. But looking at a larger picture, the stock broke below key support areas near $54 last week and is likely to test the February lows at $45 in the near future.
Ultimately, I believe NILE could trade back in the low twenties with an outside chance at dropping to “teenage” status. If investors begin to realize that the middle class consumer is having difficulty, and correctly view NILE as a company that caters to normal working people instead of a luxury demographic, shares could begin trading at a multiple that is more akin to a low-margin retailing business.
New short positions should likely place a buy-stop order above $56 as a rally back up to this level would call the timing into question. When trading short positions, stops are important as capital should be protected and losses managed. At this point I view the trade as risking roughly $5.00 for the potential to capture $25 on the decline. The risk appears overwhelmed by the opportunity for this name to trade substantially lower.
Full Disclosure: Author has a long position in the ZachStocks Newsletter portfolio.