Blue Nile Earnings Review: Stock Now Priced For Perfection

Blue Nile (NILE) is a leading online retailer of high quality diamonds and fine jewelry. Blue Nile specializes in the customization of diamond jewelry with a “Build Your Own” feature that offers customers the ability to customize diamond rings, pendants and earrings. While not providing the lowest cost diamonds, the company believes its formula of no pressure sales, high quality educational material and reasonable prices will result in higher profits.

Valuation and Recommendation

Blue Nile reported a good quarter and full year 2006, and released guidance for 2007 that is below our estimates. We believe that the pre-earnings sell off was an obvious example of the old standby “buy the rumor and sell the news”. The recalibration of the stock price was warranted and we believe the stock is now priced for perfection.

Earnings Release

Blue Nile announced revenue of $90.7M for the forth quarter of 2006. This represents an increase of 23.9% from the same period a year ago, but below our estimate of $94.2M and the
Wall Street consensus of $91.9M.

The company posted earnings of $0.35 per share beating our estimate of $0.32 and Wall Street consensus of $0.31 per share. The out performance in earnings was due to better than anticipated operational efficiencies. Please refer to the table at the end of the report that highlights the margins for the quarter and the difference from our estimates.

During the quarter, the company said that they saw strong growth in all product categories and singled out sterling silver charm bracelets, the journey diamond pendant line and diamond eternity necklaces up to $70,000 as the best sellers during the Christmas season. They noted that the quarter was very back end loaded, as shoppers likely procrastinated. Reacting quickly to this, the company offered express shipping for customers who had the intention of buying a diamond engagement ring in time for Valentine’s day. This certainly could have been a factor for all the positive momentum the stock had seen prior to the day of the earnings release.

Orders and ASP’s

The average sales price [ASP] was $1,314, up 2.3% from a year ago, but down 30% from the prior quarter. The 2005 ASP saw a quarter over quarter decrease of 27%. Orders were up 21% from a year ago, inline with our expectations of around 69,000. We have modeled in assumptions for next quarter of an ASP of $1500 and total orders just shy of 40,000. Those assumptions give us a topline number that is below guidance, and accordingly, we will be raising topline estimates soon.

Blue Nile posted 40 transactions that were priced at $50,000 or more, an increase of 74% from the year ago period. The company believes that this is a signal that there is more faith in the online model, and their brand in particular.

Traffic, Margins and the Mix

On the conference call, management noted that they continue to see increases in traffic and conversions. The goal is to get the right traffic, not just traffic growth for growth’s sake, but looking to get the right customers to the site that have the impetus to make purchases.

The product mix helped margins this quarter, and the company passed on some metal price increases. Historically, about 80% of the customers on Blue Nile were first time buyers, while around 20% were repeat customers. This quarter the company noted that they ticked over 20% for the first time. This is a positive sign that customer satisfaction is real and beginning to show in a meaningful way. We expect to see this metric climb in the coming quarters.

Shares outstanding and the buy back

During the quarter, Blue Nile repurchased 92,000 shares of its common stock for about $3.2M. This works out to an average price of $34.78. The company noted they wanted to repurchase
more shares in the quarter but were confined due to short open windows. They noted, however, that their strategy of planned purchases is giving them a benefit of 6% ahead of an open market
purchase plan. They also noted that $93.2M of the repurchase plan is still available.

Guidance and our Model

In the earnings release, Blue Nile guided Wall Street to topline of between $61M - $63M and a bottom line number between $0.14 -$0.15 per share for the first quarter of 2007. The company also guided a tax rate of 35.4% for the quarter.

For the fiscal year 2007, the company guided to $290M - $300M on the topline and between $0.80 - $0.85 per share on the bottom line. The expected tax rate for 2007 is 35.4%. Our model is calling for $58.9M on the topline and $0.17 per share in earnings for the first quarter of 2007. A modest 19.5% gross margin is also assumed by our model which might even be too low. We will likely be moving our revenue estimate higher to catch up with guidance, but at the same time we expect that higher marketing costs will offset the increase in revenue.

For the year, we had modeled total revenues of $304M, just slightly above the top end of the guided range. We do not anticipate that number to move too much from where it is now.
We also should note that we were expecting more aggressive share buy backs in both this quarter and throughout the fiscal year. As a result we will be recalibrating our model to reflect this and anticipate publishing a much higher shares outstanding number.

Recent Price action on the Stock

Over the last several weeks, shares of Blue Nile have advanced in anticipation of strong earnings. We view this mostly as a momentum play which ended the day of the earnings announcement. As in most cases of ‘Buy the rumor and sell the news’, the momentum inevitably switched sides as the stock lost 6.8% the day of the earnings announcement. In the after hours market the stock showed little movement suggesting that it has been recalibrated and once again priced for perfection.

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Disclosure: Author has no position in NILE.