Seeking Alpha
Medium-term horizon, macro, long/short equity, short-term horizon
Profile| Send Message|
( followers)  

Blue Nile (NASDAQ:NILE) will announce its Q3 sales in late October or early November as they have historically. The announcement will describe sales over the July through September period. Blue Nile has given guidance that sales will be in the $87 - $91 million range for Q3 and the average analyst estimate of Q3 sales is $89 million (right in the middle of the range provided by NILE). There are two very good reasons to believe that the Q3 announcement will disappoint these expectations, with a revenue number likely between $75 and $85 million.

1. Seasonality. The jewelry business is seasonal and, thus, quite predictable. Here are NILE's revenues broken down by quarter since 2006:

Year

Q1

Q2

Q3

Q4

2006

$ 50.7

$ 56.9

$ 53.2

$ 90.7

2007

$ 67.9

$ 72.1

$ 67.4

$ 111.9

2008

$ 70.5

$ 73.7

$ 65.4

$ 85.8

2009

$ 62.4

$ 69.9

$ 66.9

$ 102.9

2010

$ 74.1

$ 76.6

$ 67.5

$ 114.8

2011

$ 80.2

$ 80.5

$ 75.0

$ 112.3

2012

$ 83.1

$ 91.0

???

The seasonal patterns are obvious: Q2 revenue is always greater than Q1, Q3 revenue is always less than Q2 and Q4 is always greater than them all. This has everything to do with the seasonal purchases of engagement rings and gifts of jewelry in the holiday season. Notice that the average revenue drop-off from Q2 to Q3 is 7.4% which forecasts Q3 revenue of $91.0 x (1 - 7.4%) = $84.3 million, which is well short of expectations. The smallest Q2/Q3 percentage drop-off in NILE history was the 4.2% drop-off in 2009. Even this best case scenario (a 4.2% drop) predicts Q3 revenues of $87.2 million, which is below analyst expectations and on the low end of NILE guidance. Again, even in the best case scenario, history suggests a disappointment is coming.

2. Web traffic. Nile sells all of its jewelry online, which means traffic for BluenNile.com is highly correlated with Blue Nile revenue. Measuring web traffic for Blue Nile is just like counting the number of people that go into and out of a brick and mortar store. So what does Q3 web traffic look like for Nile? In a word, awful. According to Alexa [an Amazon (NASDAQ:AMZN) company], the traffic for bluenile.com during 2012 Q3 is the lowest in recent history. Here is the traffic graph from Alexa with the last three quarters shaded so that you can see the drop-off in 2012 Q3:


(Click to enlarge)

Notice a few things about the figure. First, it does a very good job predicting that Q4 revenues are the highest in each year: these are precisely the time when web traffic is the greatest. Second, notice it did a good job predicting the very good Q2 results Blue Nile had in 2012.

To formally investigate the relationship between bluenile.com traffic and Blue Nile revenues, I downloaded the history of daily bluenile.com traffic from Alexa as far back as I could go which was Q4 2007. The daily web traffic is expressed as the number of internet users per million. I then averaged the daily web traffic within each quarter so that my unit of observation was quarterly (just like my revenues). This gave me 19 observations of quarterly web traffic (from Q4 2007 to Q2 2012) that correspond to 19 observations of quarterly revenues over the same period. Using these observations, the correlation between quarterly revenues and quarterly web traffic was 77%. The rank correlation (Spearman) between the two is even higher at 83%. In other words, web traffic does an excellent job at forecasting what announced revenues will be. With this in mind, I considered a linear regression model where the dependent variable (the one I want to forecast) is quarterly revenues (Revenues) and the independent variable (the one I know ahead of time) is quarterly web traffic (Traffic):

Revenues = a + B0*Traffic

Where a (alpha) is the intercept B0 is the coefficient on Traffic, using those 19 observations gives an estimated alpha of $22.55 (t-stat 2.38) and an estimated B0 of 0.532 (t-stat 5.38) and an R-square of 60%. Using those coefficient estimates and the average web traffic in Q3 2012 of 99.90 users (per million) forecasts Q3 2012 revenue of $22.55 + 0.532*99.90 = $75.69 million. Again, compared to expectations and Nile guidance, this would be a big disappointment.

Some readers may be concerned that Alexa provides a poor measure of site traffic. Keep in mind that if the Alexa numbers were poor, I wouldn't have found a historical correlation around 80%. Garbage in would mean garbage out and I would have found a correlation close to 0%. Also, it is worth noting that other companies which measure traffic but are updated less frequently (like compete.com and quantcast.com) also find a drop-off in bluenile.com traffic during Q3. Google (NASDAQ:GOOG) Insights plots the search volume for bluenile.com (the frequency Google users type bluenile.com in the search window) like this:


(Click to enlarge)

Google Insights shows a 16% drop-off in bluenile.com search volume from Q2 to Q3 and, in general, declining search volume over the entire period. Remember that with a P/E ratio above 70, NILE must have massive growth prospects to justify current valuations. Does the above graph look like a company with massive growth prospects?

Recommendation: Given the seasonality and web traffic data, I expect revenues between $75 and $85 million, which, using the same margins as Q2 2012, would deliver EPS in the range of -1 to 8 cents, versus the company provided estimates of 10 to 14 cents.

So far, the market seems unaware of this information. After Blue Nile announced its very good Q2 results on August 2, its share price spiked from $24 to $32 and has drifted upwards since to land at around $40. I recommend selling before the Q3 earnings announcement or before Blue Nile provides guidance that Q3 sales will be lower than expected.

Source: Why Blue Nile's Q3 Revenues Will Disappoint Investors