Blue Nile: No Clear Trend in Place

| About: Blue Nile, (NILE)

Blue Nile, Inc. (NASDAQ:NILE) is trading lower than when it was first profiled here in December.  However, there still appear to be enough headwinds in place to justify a short position in the name.  Despite disappointing results in the first quarter, the stock still sports an earnings multiple of more than 40 when using consensus expectations for 2008.  In an environment that has not been kind to retailers, it is hard to imagine that the stock will not experience a sharp contraction in the price to earnings ratio based on lower growth expectations mixed with a growing sense of uncertainty.

Looking at the results from the first quarter, the company earned revenue of $70.5 million which was only 3.8% above last year’s levels for the same quarter.  This should be considered pretty disappointing for a stock that is pricing in aggressive growth assumptions. 

When looking a little closer, it appears the revenue growth was actually more a function of inflation than anything else.  The average sales price increased about 6.5% while the actual number of orders declined by 3%.  Since the company reports figures in dollars, the results were also boosted by the falling value of the dollar which leaves us to wonder what will happen if we see a rebound in the purchasing power of the US dollar.

One of the loudest arguments in favor of Blue Nile revolves around the expectation that specialty retailers of high end goods will not be affected by an economic slowdown.  The assumption is that luxury items will still experience demand as rich consumers buy jewelery and other high priced goods. 

However, NILE noted that the strongest segment of products was diamond items below $5,000.  So it now looks like the company is not seeing particularly strong revenue from higher end purchases.  I imagine that a $15,000 to $30,000 purchaser would prefer to walk into a physical luxury store instead of making the same purchase online.

Looking at the company’s margins, we are still hard pressed to find encouraging metrics.  Operating margins were actually down for the quarter as an increase in SG&A expenses was greater than corresponding sales growth.  Management is expecting 2008 to be “back end loaded” meaning the majority of incremental sales growth will occur in the second half of the year.  If this is not the case, and SG&A and other expense items remain at current levels, we can expect to see erosion in the profit line fairly quickly.

There are certainly bullish arguments from some analysts who still expect growth due to international expansion and other promotional pushes.  However, even those with bullish expectations are counting on economic expansion to propel higher sales.  With energy prices spiking higher, financial companies creating uncertainty, and consumer confidence at historically low levels, it seems unlikely that over the next several months consumers will move in droves toward luxury purchases.

The best overall investment themes still rely on execution in order to become profitable.  Blue Nile is a difficult stock to trade because there is no clear trend in place right now.  As such, I find it difficult to recommend a short position (that’s not what this site is about anyway), but I do think caution is warranted.  A break below $40.00 on volume would seem to validate my concerns and short positions in this area would likely meet with success.  The market has become difficult to navigate for many so it is prudent to keep position sizes small and exercise careful risk control.

NILE Notes

Disclosure: Author does not have a position in NILE.

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