My last Blue Nile (NILE) conference call article was Third Quarter 2009. Back then, Blue Nile's stock price was $60.84, and this past Friday it closed at $50.53. I was bullish then and I remain bullish now.
Some will point to a substantial drop in stock price as evidence that I was wrong. While that is true, I suspect only a few of the bears were able to top tick the short at its recent high. Please see the two year price chart below. Blue Nile generally has extraordinarily high short interest, with Yahoo! Finance reporting its current short interest at 33 days or 55.4% of the float.
Please note, you can click on the charts to see full-sized images.
On 15 February 2010, Barron's Magazine wrote a bearish article. Let's look at a few brief snippets from the article and then move forward to the latest conference call.
One investor who has sold the stock short and asked not to be identified thinks it could fall to 35, given weak demand and intense competition in the fine-jewelry market. He said he might cover his short position if the shares hit 40.
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Yet data on unique visitors to the company's Website suggest cause for concern. According to Compete.com, a Boston-based analyst of online data, the number of unique visitors to Blue Nile's Website declined year over year nearly every month in the past year, while many bricks-and-mortar jewelers, Tiffany included, saw increased traffic from visitors on the Web. Based on Compete's data, Blue Nile controls 4.3% of Internet jewelry sales.
Viewed over two years, the number of unique visitors to Blue Nile's Website also is down sharply. In November and December of 2007, big months for jewelers, Compete counted a total of 823,684 unique visitors to the company's site. In the same two-month stretch of 2008 it counted 681,666; last year it clocked only 583,697.
One unidentified investor who is afraid to attach his or her name to his or her comments thinks the stock could fall to $35. Of course, anything is possible, especially now with the world's financial order at the edge of the precipice. However, since the stock never fell to $40, is he or she still short? If so, it must have been an interesting ride from $48.18 on 17 February to over $58 in mid-April to back to nearly $50 now.
Next, we get the same old web traffic companies trotting out bogus statistics. Earlier in a prior article, I debunked their claims. And if that weren't enough, let's look at the historical revenues as shown by the chart below.
How can it be that sales are increasing while ...the number of unique visitors to Blue Nile's Website also is down sharply? Over the past two years, what are the cumulative reductions in web traffic reported by comScore? By Compete? If their trends continue, when do Blue Nile's servers fall silent with Blue Nile experiencing increasing revenues?
And, of course, the article discussed a planned sale program by the executives as evidence that all is not well. The executives have sold stock high and low. They are merely exercising prudent financial management by diversifying their net worth.
As we'll soon learn, Blue Nile purchased stock at an average price of $52.04. You must ask yourself, if insiders believed that Blue Nile was destined for $35 per share, as our anonymous short seller believes, would it not be prudent to wait? Of course, management cannot predict with any accuracy--nor can anyone else--the stock price tomorrow, next week or next month. Instead, management must use its judgment and make an informed decision as to whether purchasing stock and returning cash to shareholders now makes sense.
Now let's turn our attention to the press release and recent conference call. I will use point form.
Press Release
- Record first quarter sales of $74.1 million, representing growth of 19%.
- Non-GAAP adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) grew at 17% to $6.2 million.
- Earnings per diluted share increased 23% to $0.16.
- Operating margin expanded 10 basis points to 4.8% of net sales compared to Q1 2009.
- Net income improved 23.1% to $2.4 million or $0.16 per diluted share compared to $1.9 million or $0.13 per diluted share Q1 2009.
- Net cash provided by operating activities totaled $29.8 million for the trailing twelve month period ended April 4, 2010.
- Non-GAAP free cash flow for the trailing twelve month period ended April 4, 2010 increased 133% to $27.5 million from $11.8 million a year ago.
- International sales increased 71.4% to $9.6 million, a new company record. Excluding foreign exchange effects, international grew at 51.8%.
- Gross profit totaled $15.8 million. As a percentage of sales, gross profit improved 10 basis points to 21.3% compared to 21.2% for the first quarter of 2009.
- Selling, general and administration expenses were $12.2 million, compared to $10.3 million in Q1 2009. Percentage wise, SG&A costs were the same as Q1 2009.
- Net income per diluted share for the quarter includes stock-based compensation expense of $0.08 for both the first quarter of 2010 and 2009.
- During the quarter, the Company repurchased 292,100 shares of its common stock for $15.2 million. At the end of the first quarter, cash and cash equivalents totaled $47.2 million (which calculates to an average price of $52.04 per share).
- Expectations for the full year 2010 (Year Ending January 2, 2011):
- Net sales are expected to grow at least 15% over 2009 levels; and
- Diluted earnings per share are expected to grow at least 20% over 2009 levels.
Conference Call (skipping over much of the information already covered by the press release)
- Traffic to Blue Nile's web site grew y-o-y, and conversion increased to an all-time high. Company experienced healthy increases in orders and average sales price. Repeat sales showed strong growth for the quarter.
- Sales of non-engagement jewelry grew above overall average sales growth rate. Customers made more discretionary purchases than a year ago.
- Strongest growth was at price points above $25,000, with total sales for price points above $25,000 near record Q1 levels.
- Company believes it is continuing to gain market share by offering high-quality diamonds that are 20% to 40% below physical retailers and world class high-touch customer service.
- In the first quarter, international sales increased 71% to $9.6 million, representing 13% of total sales.
- Its new Chinese language web site, launched in early April, was Blue Nile's first non-English language web site.
- Current web site features new enhancements. First, customers are able to store their order histories, which simplifies the repeat purchase process and provides wish list functionality along with other benefits. Second, new financing options are available. And third, a new diamond and jewelry search. iPhone and Android mobile devices can compare prices, quality, and search more than 60,000 diamonds.
- Sales in the U.S grew at 13.6%, with international sales at 71.4% or $9.6 million. On a constant currency basis, international sales grew at 51.8%. Strong growth was evident in U.K. and Canada. There was strength in the Asia, Pacific, and European markets.
- SG&A totaled $12.2 million for the quarter, compared to $10.3 million in the first quarter of 2009. SG&A included $1.8 million in stock compensation expense in the first quarter of 2010 and 2009. Excluding stock-based compensation expense, SG&A as a percentage of sales was 14.0%, compared to 13.7% in the first quarter of 2009.
- The increase in SG&A is partially attributable to higher marketing this year over last year. Last year, Blue Nile reduced its advertising in response to the harsh economic conditions. Current levels are near normal levels.
- There were also investments in technology as part of the G&A increase.
- Operating income for the first quarter totaled $3.6 million, representing an operating margin of 4.8%, a 10 basis point improvement from our 4.7% operating margin a year ago.
- Company ended quarter with a cash balance of $47.2 million. Every Q1, company incurs a significant payables hit from Q4. Moreover, 292,100 shares were purchased for 15.2 million (which translates to $52.04 per share). Blue Nile still has about $100 million approved for additional purchases.
- Inventory was 21.3 million, an increase of $1.8 million from Q1 2009. Although this level is slightly above ideal, the Company is preparing its spring launch and providing additional product depth. During the year, Blue Nile expects inventory to return to historical levels.
- Inventory turnover for the trailing 12 months improved to 13.6 in Q1 2010 from 12.8 in Q1 2009.
- Return on invested capital, defined as trailing 12-months free cash flow divided by the average total assets, less current liabilities for the past five quarters, was 81% for Q1 2010, compared to 48% in Q1 2009.
- Guidance:
- Maintaining sales growth at 15% or greater and diluted earnings per share at 20% or greater.
- Capital expenditures at about $3 million.
- Quarterly guidance has been dropped in favor of a longer-term focus.
Question and Answers
- Fluctuating currencies presents challenges and opportunities. As the British pound and Euro lose value, headwinds are created in U.K. and Europe. However, because the U.S. dollar is relatively stronger and diamond values tend to depreciate in U.S. dollar terms, U.S. consumers have more purchasing power.
- Diane Irvine mentioned that Blue Nile experienced a solid April.
- When repurchasing shares, Blue Nile does establish target levels at which it wants to purchase shares. If shares are trading above trading levels, Company waits until an opportunity presents itself rather than acting in an aggressive fashion by chasing higher price levels.
- Mark Vadon stated, "I just wanted to throw out one more think about, as we are looking at traffic growth and conversion. Again, this quarter we had a third-party firm announce that they thought our traffic was down a pretty alarming amount. And this seems to happen every quarter. And the market seems to react to it every quarter. And we always tell people we're sitting here looking at our servers, and that data from third parties is not accurate. So, I would just want to take this moment to caution people to try not to pay so much attention to third parties who actually don't have real data."
- Diane Irvine commented that, ignoring growth considerations, Q4 is the largest quarter with Christmas. Next is Q1 with Valentine's Day. Next is Q2 with Mother's Day. Q3 is lowest in sales but highest in margins because there no important holidays to drive sales and engagement rings. Thus, there are a higher proportion of jewelry sales in Q3 that carry a higher margin. With the company growing rapidly, these trends are sometimes influenced by Blue Nile's underlying growth. In other words, these are guidelines but not absolutes.
After reviewing this conference call's information and absorbing the market events during the past two weeks, I believe the analysis is simple. If problems in Europe continue to worsen significantly, then that event might cause trouble for most American stocks too, including Blue Nile's. If, on the other hand, Europe stabilizes and America continues to recover, then I expect Blue Nile's stock to outpace most others.
During the conference call, Blue Nile indicated that as the Euro falls, the U.S. currency becomes relatively stronger and the U.S. consumer is able to purchase more diamonds, because, although diamonds are priced in U.S. dollars, they would likely fall in price. While I agree with that statement as given, there is one part missing. If European troubles escalate rapidly, then all economies are likely to slow and consumers become cautious.
For those that believe that Europe will continue to deteriorate rapidly, they should avoid Blue Nile. And for those that believe that we are recovering, then they should consider Blue Nile. As evidenced by most metrics, Blue Nile continues to execute superbly in an industry that is faltering and in disarray. Moreover, Blue Nile continues to gain market share by offering quality products at substantially lower prices. Simply put, the company continues to grow, even in a difficult market.
We have also learned that Blue Nile is a willing buyer of its own stock at a price of around $52. This price is subject to change, however. If problems in Europe escalate, I am sure that Blue Nile would reduce its target level for purchasing more stock, if not stopping altogether. Do I expect to see the $35 target price of our mysterious short seller? No. On the other hand, if the markets stabilize and resume growth, the target level might even be raised.
The other consideration is Blue Nile's international growth. As revealed during this conference call, Blue Nile is enjoying rapid international growth. What is especially important is that Blue Nile can continue to serve more markets at a very low cost because its business model is capital light. Recall that the return on invested capital is an amazing 81%.
I have deliberately not commented on various metrics such as price-to-earnings multiples and such. The reality is, Blue Nile stock always has high price-to-earnings multiples. Moreover, the uncertainty surrounding key inputs such makes most valuation formulas tenuous at best. One analyst might forecast low growth rates while another might forecast significantly higher growth rates. These growth rates are highly dependent upon the recovery. Once the world economies stabilize and we can better estimate future growth trends, then I will place more emphasis on valuation formulas.
In assessing Blue Nile, the question effectively becomes: Are we experiencing a recovery where consumers will continue to spend discretionary funds or are we about to experience another severe economic shock that will cause consumers to become extraordinarily cautious again?
Disclosure: I am long Blue Nile shares.
On Saturday, 15 May 2010, I photographed Glenmore Reservoir while looking west. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.
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