Strong Third 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; and
• Outstanding Second Quarter 2007 For 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 strong, indicative of a well managed and growing company. To be honest, I was unsure of the company's performance this quarter. With the housing and energy issues, I was unsure of the company's performance. The company's performance, however, indicates that it is doing well.

From the company's conference call transcript (courtesy of Seeking Alpha):

Analyst for Imran Khan - JP Morgan

A quick question just about holiday sales. Are you expecting non-engagement sales to trend, given the tightening economy? Have you seen any changes in competition domestically from people such as Amazon for holiday season?

Diane Irvine

In terms of holiday trend, I think as we had mentioned in our comments earlier, as we have started the quarter we're seeing very strong momentum so that is great. I think in terms of consumer spending or what you see more broadly, I think we have always said we don't exactly know. I think there's a very strong argument that when you look at engagement, that is less discretionary. I can only point to what we're seeing, which is great strength in the business, even stronger at the beginning of Q4 I'd say than what we saw in Q3. Of course we are taking share, so I think we're a bit different than you see in retail broadly. But I think we feel very optimistic today in that we're well positioned for the holiday season.

In terms of competition, I would really just point to what Mark talked about earlier, that I feel every quarter we get ahead of the competition and really expand our lead. Mark mentioned our international business as being larger than any of the US competitors in terms of engagement online. I think we need to continue to get better and better at what we're doing, which is why we focus so heavily on the customer experience. I think you see that happening.

Similar to my prior article on Blue Nile's last quarter, 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 $67.4 million, an increase of 26.5% over the third quarter of 2006;
• Gross profit grew by 28.4% to $13.4 million, and operating income grew by 67.3% to $3.6 million;
• Net income of $3.0 million and net income of $0.18 per share, representing an EPS growth of 63.6% over the same period last year;
• In Q3, total orders increased 16.3% as compared to a year ago.
• Average selling price per order was $2,093 in the third quarter, up 11% to $1,884 from the same period last year;
• Website traffic growth strong, stronger than it has been during the last couple of years; and
• Sales and merchandise priced above $25,000 grew by over 50%.

Similar to the last quarter's earnings release and conference call, 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. You should keep in mind that in two to three months the forward P/E will be based upon 2009 earnings, not 2008. If assume 25% growth in earnings for 2008 and 2009, then 2009 earnings will be about $1.60 per share. With the current price of about $80 per share, Blue Nile has about 50 multiple on forward earnings for a company that is growing at 25%. Because the company is still in the early phases of its growth, I think the valuation is very reasonable.

Note that my 25% growth value was arbitrary. The company exceeds 25% growth for many of its metrics. I chose 25% because it was a convenient number that was near the net sales growth this quarter. My guess is that the actual growth rate will be higher.

Blue Nile indicated that it is taking share away from other jewelry retailers. As mentioned in my prior Blue Nile earnings, I believe 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 3.36 million shares short, which with a float of 11.25 million shares, means that about 22% – 30% of the shares outstanding are short. That translates into a short interest ratio of about 5 to 8 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 3.46 million shares. While both providers' values are reasonably close to one another in our situation, I find it helpful to check both.

I continue to be an enthusiastic supporter of Blue Nile. Today the S&P is down 1.88% to 1491.72, while NILE is up 9.31% to $81.63. Prior to the second quarter (not third), the price was near $83. The stock price has been volatile during the recent quarter with the price having reached slightly over $100 and falling back to low $70s before bouncing back today to the low $80s.

As stated in my first quarter summary, I do not have a target price for Blue Nile. I continue to monitor the stock. 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 are not a recommendation. You must perform you own independent analysis and make your own independent decisions.

Disclosure: I am long Blue Nile stock, short calls, for a net long position. Please note, I maintain a core long stock position and trade around Blue Nile using both stock and options.

Update

The market closed down today. The Dow fell 360.92 to 13,300.02, a loss of 2.64%; S&P fell 44.65 to 1,475.62, a loss of 2.94%; and Nasdaq fell 76.42 to 2,748.76, a loss of 2.70%. Blue Nile stock closed up $6.83 to $81.51, a gain of 9.15%.

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.