An Outstanding Second Quarter 2007 For Blue Nile

As preparation for this article on Blue Nile, Inc. (NILE), you might wish to review some of my prior articles:

• Impressive First Quarter For Blue Nile;
• Not Paying Attention To The Blue Nile Bears;
• Blue Nile Bull And Bear Square Off; and
• Citigroup Upgrades Blue Nile.

To set the stage, I used Yahoo's financial website to pick up the analysts' estimates prior to the conference call.

I updated the table below to reflect actual values and company forward guidance.

As you review and compare the information above to my prior articles, you will note that guidance has gone up, again. Blue Nile is a classic underpromise, overdeliver company.

This most recent quarter's results are nothing short of outstanding. The company exceeded expectations on almost every metric. During the conference, the company was rightly pleased with its performance and enthusiastic about its future. If you are at all interested in Blue Nile, I highly recommend that you read the conference call transcript, which is available freely from Seeking Alpha. Two quick side notes: one, I am amazed at how quickly Seeking Alpha is able to provide written transcripts following the conference call; and two, I am a contributor to Seeking Alpha. When you read the conference call transcript, you will get the strong sense of optimism and confidence that the senior management team has about their business.

Rather than parsing through the conference call in detail, I am going to provide some quick snippets to give you a sense of how the company is performing.

• Net sales of $72.1 million, an increase of 26.7% over the second quarter of 2006;
• Gross profit grew by 32% and operating income grew by 39.8%, both were the highest that Blue Nile posted as a public company;
• Company claims to extend leadership position in online diamond and jewelry retailing as evidenced by its net income of $3.8 million and net income of $0.23 per share, representing an EPS growth of 28%;
• In Q2, total orders increased 27.2% as compared to a year ago;
• Average selling price per order was $1,630 in the second quarter;
• Website traffic growth was the highest since mid-2004;
• All retail channels—search, portals, partners, and email—were all very strong; and
• Sales and merchandise priced above $25,000 grew by 51%. One exceptional example was a single sale above $1.5 million from a repeat Blue Nile customer.

In listening to the conference call and reading the transcript, I did not find anything any weaknesses or causes for concern. The company is performing extraordinarily well and is getting bigger and stronger with time. The key consideration is valuation, of course. Let us look at some quick numbers.

The values quoted above will be modified once the company's latest results are incorporated. By using traditional or standard metrics, the valuations look rich, but not wildly so. If we accept Jim Cramer's general advice, for example, and believe that we should not pay more than two times the growth rate, then we find that the current price of Blue Nile is perhaps a bit high. In the press release, the company stated that its latest earnings growth rate is 27.8% year over year. Doubling that value, we get a forward P/E value of about 56. The current forward P/E value is higher than 56; it is closer to three times the earnings growth rate. However, we also note that the company just experienced its highest growth rate as a public company. Perhaps we will witness even higher growth rates in future quarters. Thus, I do not find the current forward P/E troubling.

Furthermore, I expect that Blue Nile is taking substantial share away from the traditional brick and mortar jewelry retailers. I expect when major traditional jewelry retailers have their earnings releases and conference calls, we will learn that mall traffic is down, housing and other economic woes are slowing discretionary spending, and business remains challenging. (Keep the Blue Nile conference call transcript handy to do a compare and contrast exercise.) I expect that we are witnessing a transfer of value from the traditional retailers to Blue Nile and its customers. Thus, I am not fussed about the current forward P/E ratio because one, Blue Nile is performing exceedingly well operationally and two, Blue Nile is still a relatively young and relatively small company with plenty of potential growth ahead of it.

According to Yahoo and Short Squeeze there are about 2.67 million shares short, which with a float of 11.13 million shares, means that about 24% of the shares outstanding are short. That translates into a short interest ratio of about 11 to 12 days. Remember, the short interest ratio is the number of days of average trading to equal the total outstanding short position. Both providers indicate that the number of shares short increased from the prior month's value of 2.46 million shares. While both providers' values are reasonably close to one another in our situation, I find it helpful to check both.

I also noted that on today's CNBC show Fast Money, all four of the panelists believe that Blue Nile is a buy. Dylan Ratigan interviewed Blue Nile's Chief Mark Vadon. Because Blue Nile enjoyed such a successful past quarter, Vadon had an easy and pleasant interview.

I continue to be an enthusiastic supporter of Blue Nile. On the markets as a whole, I am cautious. Should the markets have a particularly difficult day, investors might find that they can purchase Blue Nile for less than it is trading today, which was $83.00 in after hours trading. I expect Blue Nile to surpass $83.00 tomorrow. The shorts will once again be disappointed and will need to reevaluate their positions.

As stated in my first quarter summary, I do not have a target price for Blue Nile. I continue to keep my eyes sharply focused on the stock and, so far, am a happy camper. I believe the company is well managed and poised for even greater success. For those that are interested in investing in Blue Nile, I highly encourage you to read the conference call transcript to form your own independent assessment. My enthusiasm for the company and its stock is not a recommendation. You must make your own independent decisions.

Disclosure: I am long Blue Nile stock.

Calgary model Judith Aldama is featured in the photograph above, which is hosted at Flickr. If you click on the picture of Judith, you will be taken to where you can view a larger version and see even more pictures of her.