Blue Nile Appears Highly Overvalued

Blue Nile’s stock (NILE) initially traded higher after reporting Q3 numbers at the beginning of November. While revenues were a bit disappointing (only meeting analysts' expectations), earnings were above estimates and 64% above the earnings from Q3 of 2006. Management was very upbeat on the conference call and even increased their 2007 guidance for both sales and earnings. Management now expects sales of $109 to 115m for Q4 and earnings of $0.40-0.45 leaving us with a full year 2007 number of $1.00 to $1.05.

While the headlines read “management raises guidance,” the fact is that the strength was largely in the third quarter and guidance for Q4 is not that impressive when comparing it to Q4 of 2006. If earnings come in at the top end of the range, it will represent a 15% increase annually which is far slower than its growth of previous quarters. While 15% growth is attractive, it hardly justifies a multiple of 70+ times current earnings which is where the stock is trading right now.

Digging into the conference call, I noticed that management stated much of the strength was from its international sales which were up an astounding 105% year over year. This sounds great until one realizes that the company re-launched its two international websites this year so of course the percentage gain would be significant given the anemic base international sales were starting from. While this could definitely be an area for the company to explore for growth, the numbers are fairly light at this point and there is little evidence that an international push is really gaining traction.

The company is flush with cash. Cash levels have risen to a point where there is $4.40 per share sitting in the bank. While Blue Nile has re-purchased shares in the past, analysts were surprised to note that this is the second quarter in a row that the company has not repurchased a single share. When asked about this fact, management said they would not be averse to using cash for share repurchases but wanted to wait for a more opportune time. This implies that management views the stock as at least somewhat overvalued and is holding their cash until they are able to employ it at lower price levels.

As mentioned, valuation is extremely high for the growth rate currently being observed. This is certainly no reason outright to short the stock, but the price pattern is shaping up to confirm what the fundamentals are saying. It would have been foolish to short NILE in the 70’s this summer as momentum was strong and traders continued to bid up the shares. But as we transition to a market that is showing weakness, and consumers are showing more signs of fatigue, NILE’s stock has begun to weaken and was not able to participate in the recent market strength. This is a telltale sign that institutions are not accumulating shares and serves as a red flag to anyone long this retail name.

Investors will likely be disappointed with the Q4 numbers and in the meantime, bad general data points for consumers should carry weight for this stock in particular.

Full disclosure: Author has a short position in NILE

Comments

[jcrash:]

Takes a whole article to say that a P/E over 50 with a growth rate of sub 30 makes no sense?

2007 Dec 07 11:17 AM

[borisb:]

i like the perception but would like to see more concrete justification. your point on international traction being suspect is probably off considering they are the highest volume player in both markets. as the international maintains some momentum this adds about 7% to 10% to the top line in addition to whatever the US growth rate is. Also during the confrence call management stated they have alot of operating leverage as the last quarter the operating leverage upticked right in front of the busy 4th quarter, implying that if sales are strong in the 4th quarter the company is quite sucessful and will beat again. i think the part you are missing is they beat and they may beat again. i will get back to you. otherwise you short work overall has been stellar!

2007 Dec 08 07:24 PM

[valueman:]

I was wondering how you got that mgmt Q4 forecast represents 15% year-over-year growth. Top line, they are forecasting revenue between $109mm and $115mm. The top end here would represent 27% y-o-y growth. And similarly with EPS forecast. I do not disagree with your short thesis, but I do think your numbers may be wrong.

2007 Dec 13 09:13 PM

[Zachary Sch...:]

Jcrash - sorry if I got too wordy. Trying to give you some background information.

Thanks Boris - I got a different feel from managements call - didn't appear to be as optimistic as you imply. At any rate, it takes a whole lot of international expansion to justify the multiple.

Valseek - I think you're looking at sales and yes you are correct at 27% y/y growth. I am looking at EPS which management has guided to 0.45 at the top end versus 0.39 last year.

Thanks for the comments guys!

2007 Dec 17 04:12 PM