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On the guidance, I think we’re seeing what a lot of luxury retailers are seeing, is that consumers are behaving very differently over the last 10 weeks than they have been for quite some time. We had a weak January and things have actually picked up slightly going into February but, where we sit today, it’s pretty tough to give guidance for the full year just to be perfectly straight with you guys. What we saw in January was people pulled back. When I talked to people in the channel they’re telling me that stores are absolutely dead. We don’t know how long this continues, whether what we’re seeing is a reaction to people spending what money they were going to spend at Christmas time and then pulling back now, or if it’s something more sustained than that. So, our mindset is to give conservative guidance based on where we’re standing today and then if the situation improves, which we’re hopeful it does, we’ll continue to update. But, from a macro perspective our goal is really just to gain share. That’s all we can do. We can’t change whether or not consumers are going to come into the market to make a purchase but we can do our best to try taking those consumers when they do, and I think we’ve been doing that well for almost nine years now and regardless of what the market does we will grow faster than other people. That’s our intent and I think we’ll do that.

Our guidance is for that as well. The other anomaly we’ve seen over the last few weeks is that very high-end of the market, those price points above $25,000 that were healthy for a very long time for ourselves, as well as a lot of the other luxury players out there are all of a sudden very, very weak. I think we said in the call that high-end sales were 50% growth or above every single quarter of last year. We definitely didn’t see that in the last couple weeks of December and in January. I think the very, very high-end consumer is finally showing some vulnerability out there. The guidance we’re giving today is based on what we’ve seen so far. But if that changes we’ll update people.

The above quote of Mark Vadon, Blue Nile, Inc. (NILE) Executive Chairman, from Seeking Alpha's Transcript of the Blue Nile 4Q 2007 Conference Call explains why the stock was hammered.

Because I am late in providing my thoughts on the conference call, I will provide a shorter than usual article.

Key points from the earnings release and conference call are as follows:

• Gross profit for the quarter grew 25.9% to $23.7 million, from $18.8 million for the fourth quarter of 2006. Gross profit as a percentage of sales increased to 21.1% for the quarter, compared to 20.7% for the fourth quarter of 2006.
• Net income per diluted share for the quarter includes stock-based compensation expense of $0.06, compared to $0.04 for the fourth quarter of 2006.
• International sales totaled $7.2 million in the quarter, an increase of 155% year over year. For the full year, international sales totaled $17.2 million, a 108% increase compared to sales of $8.3 million for fiscal 2006.
• For the full year, net cash provided by operating activities was $41.5 million compared to $40.5 million for fiscal year 2006. Non-GAAP free cash flow for the year totaled $36.6 million, compared to $38.6 million in the prior year. Free cash flow for 2007 includes the change in deferred income taxes related to the full utilization of net operating losses for income tax purposes in 2006, as well as higher capital expenditures for 2007 related primarily to the expansion of the Company's domestic fulfillment center.
• The effective tax rate for the quarter was 33.3%, compared to 35.5% for the fourth quarter of 2006. The lower tax rate is primarily due to deferred tax asset adjustments. The Company's effective tax rate for fiscal year 2007 was 34.3%, compared to 34.6% for fiscal year 2006.
• Capital expenditures in the fourth quarter totaled $1.3 million, compared to $0.2 million in the fourth quarter of 2006. Full year 2007 capital expenditures totaled $4.9 million compared to $1.9 million in 2006. The higher capital expenditures for 2007 relate primarily to the expansion of the Company's domestic fulfillment center.
• During the quarter, the Company repurchased 94,100 shares of its common stock for $6.5 million. For the full year, the Company repurchased 438,755 shares of its common stock for $20.0 million.
• The average sales price in 2007 for an engagement ring sold on the website was just over $6,200, well above the industry average.
• The international efforts are realizing tremendous success, despite a cautious U.S. outlook.
• During the quarter Blue Nile repurchased 94,100 shares of stock for $6.5 million. For the full year 2007 it repurchased 438,755 shares of stock for $20 million.
  • Average purchase price for last quarter was $69.08 and for the year, $45.58.
• Net sales are expected to be relatively flat with Q1 2007.
• Net income is expected to be in a range of $0.11 to $0.14 per diluted share. The estimated net income per diluted share includes the estimated impact of stock compensation expense of approximately $0.07 per diluted share, compared to $0.05 per diluted share in the first quarter of 2007.
• The effective tax rate for the quarter is expected to be approximately 35%.
• Goal is to grow net sales by at least 10% for the year and to grow non-GAAP adjusted EBITDA by at least 10%.
• Net income per diluted share goal for 2008 is to achieve a GAAP EPS level that approximates 2007.
• Stock compensation expense for the year is estimated at approximately $0.29 per diluted share, an incremental impact of $0.07 per diluted share compared to 2007.
• The effective tax rate for the year is expected to be approximately 35%.
• Capital expenditures are expected to be approximately $2.5 million.

If you examine Blue Nile's history of buying back shares, you will note that the company has been opportunistic in its purchases. The average cost of its purchased shares last year was about $46 and for the last quarter it was about $70 per share.

I encourage you to listen to the conference call or read the transcript. While I certainly acknowledge the negative effects of U.S. housing slowdown, I do not think the country is headed for a major recession. The economy might worsen in the near to intermediate term, but it will strengthen again. And as Diane Irvine, President and CEO, indicated during the conference call, Blue Nile is well positioned against its traditional brick and mortar competition with their higher costs structures. I agree her assessment that 2008 represents a tremendous opportunity.

Disclosure: I am long Blue Nile stock and call options.

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

I have been extraordinarily busy this past week, so I did not watch the markets as closely as I normally do. I did, however, purchase more oil stocks and stocks in a couple other sectors. Although I did not load up the proverbial boat with oil stocks, I might further increase my exposure soon. Those who follow my blog know that I am an oil bull, believing that oil prices will continue to rise because of the inability to match supply with demand at current prices. However, there might be some further downward pressure on oil stocks as northern hemisphere enters the spring season and the demand for oil is temporarily lessened. Of course, the current market turbulence might further add to the downward pressure.

That said, I believe that the stocks of oil companies are unlikely to fall much further. Put differently, there is much more upside than downside, especially as you lengthen your time horizon beyond one year. As time progresses, the world demand for crude oil will continue to increase. As the volume of oil consumed increases, the amount of crude that must be found just to replenish the natural decline of existing oil fields also increases. And then, more oil must be found to satisfy the increased global demand. Thus, those companies that have large reserves should do well.

The photograph of Model Linda T is hosted at Flickr. In this photograph, Linda posed in front of a train in the Heritage Park train roundabout. (See Google map:
View Larger Map.) If you click on the picture of Linda, you will be taken to my Flickr account where you see even more pictures of her.

Doug Kass, general partner of Seabreeze Partners Management, Inc. and commentator for The Edge Column on RealMoney Silver (subscription required—part of TheStreet.com family) covered his short position in Zale Corporation (ZLC). I followed suit.

In an earlier article, I provided my rationale as to why I was considering covering my short position in Zale early in the New Year. Now that the stock has fallen even more and because Doug Kass mentioned that he is getting out of the short position, I am ringing the register and closing my short position as well. I shorted Zale in March of 2007 and I covered today. You can see the Yahoo chart on Zale's stock price movement since March 2007.

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.

Disclosure: No position in Zale.

I am currently experiencing difficulties with my Flickr account. I have a hunch that the outcome is not going to be good. In any event, I ask for your patience with my site while I work on solving my Flickr difficulties.

Update

I have lost all my pictures, comments, favorites, contacts, and friends on my Flickr account. You can read a more detailed explanation of what purportedly happened. I will comment more on this topic in a day or two. So please bear with me and my blog while I get reorganized.

To those who celebrate Christmas, I wish you a Very Merry Christmas and a Happy, Healthy, and Prosperous New Year! I further hope you are enjoy spend this time of year with your friends and family.

Switching topics slightly, I know that digital cameras are a popular item for Christmas. If you are looking excellent online resources to help you learn how to use your Canon or Nikon digital camera, particularly digital single lens reflex cameras—dslr— or Adobe Photoshop, I highly recommend two websites:

• ProPhoto Home; and
• Chromasia Photoshop Tutorials.

ProPhoto is an outstanding online community where photography enthusiasts and professionals discuss everything about photography. If you want to learn about your camera or about photography in general, you will find the ProPhoto members extremely helpful. Moreover, because this online forum is aimed at those who are serious about photography, the discussion is friendly and helpful. While the forum does have a large number of experienced photographers, there are also those like me who are still very much at the learning stage. What I really enjoy is the diversity of answers. Different photographers will provide different approaches to solving the same challenge. As a student, you can try several different approaches to see which best fits your style.

I have been following David J. Nightingale's Chromasia photoblog for quite some time. He recently decided to share his Photoshop knowledge with those of us who admire his photographs. So far, I have worked through Chromasia's tutorials on the following subjects:

1. Tonal range and the Curves tool;
2. Landscapes: creating dramatic skies;
3. Black and white: part one;
4. Toning colour images; and
5. Portraits: part one.

David produces one tutorial per month. His next tutorial, soon to be released, will be: An introduction to Lab Color mode.

David's tutorials are extraordinarily well done. His explanations are thorough and complete, and he provides sample files. Moreover, he has an online forum where he answers questions. Even though Photoshop can seem complex and daunting, David's well organized tutorials allow you to work you way through the material while gaining a strong comprehension of the material.

This past year, I have become more interested in Photography. I have read several books on photography and Photoshop. And I have begun practicing taking pictures. The most important thing I have learned this past year is how much I do not yet know. There is so much to learn. If you are just starting out, like I was, you need to understand how your camera functions. You need to learn about light and color. You need to understand how to use Photoshop effectively. If you are working with people, you need to learn how work effectively with them to get great pictures. And the list goes on. Asking others is a great method to shorten your learning. I have found that just a quick few words of advice often pointed me in the correct direction. That as a backdrop, I heartily recommend these two online resources to help you learn more about photography.

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.

I just received my new book War and Peace from Amazon. I want something fictional to read over the holiday period. After briefly flipping through the book, I am a bit intimidated by its length. I read the introduction by Richard Pevear and Larissa Volokhonksy, who both translated Leo Tolstoy's original Russian book into the English equivalent. I learned that Leo Tolstoy wrote his book between 1863 and 1868, starting when he was thirty-five. My understanding is that the book covers Russian life during the period of the Napoleonic wars of 1805 to 1812. My knowledge of history in general is weak, let alone this specific period. The book, however, does provide notes at the end to explain the various events that were taking place as well as the important people. Words and phrases are explained too.

Although I am looking forward reading Tolstoy's book, I am certain that it will take me several months to complete. The book looks reasonably complex with several different characters. Furthermore, the impression I have from reading the introduction is that this book does not follow the traditional novel format. So it will be an interesting journey.

On Amazon, there are 27 reviews with an overall average rating of 4.5. Given that almost all those who reviewed the book gave it the highest possible rating, I am certainly looking forward to reading it.

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.

The New York Times has an interesting article Remaking The Journal (free registration required) that hints at possible changes to the The Wall Street Journal. As a subscriber to the Wall Street Journal, I was saddened when it got taken over News Corporation (NWS), because I fear it will suffer the same fate at CNN. When Ted Turner ran CNN, it was edgy and interesting. Along came AOL with its remaking of CNN and removing the edge. While it might have enjoyed a wider audience, it also became less informative and interesting to watch. I fear the same thing happening to the Wall Street Journal.

Mr. Murdoch has said that he wanted The Journal to step up its coverage of politics and national and international affairs, making it a more direct competitor to The New York Times. He has lobbied for more hard news and more succinct articles — a marked shift in tone for a newspaper whose signatures include long, often quirky news features that start on the front page.

There has even been talk of a front page with articles short enough to start and end there rather than continuing on inside pages, and of taking the words “Wall Street” out of the paper’s name to give it broader appeal, according to people who have been briefed on the matter. Both ideas were quickly dismissed, but the fact that they were raised even semiseriously shows how unconstrained by tradition the new owner is, these people said.

...

None of that should be surprising from Mr. Murdoch, who is known for being sure of what he wants to do with each of his many properties — often molding them to reflect his own views and wasting no time in doing it. His habit of detailed, personal control contrasts starkly with decades of hands-off ownership by the Bancroft family, which viewed almost any involvement as unethical meddling.

I, for one, often enjoy the front page, long quirky articles. I find those articles to be a refreshing break from the constant barrage of facts, figures, and strong opinions. Moving along to the free with advertising versus subscription based model, I favor the latter. I do not want to be constantly bombarded with advertisements that I need to move out of my way to read an article. I prefer a clean, uncluttered look. In my view, the online WSJ has a balanced approach now with advertising and content. One partial solution that I do like is Barry Ritholtz's solution of allowing the archives to flow freely. In essence, paid subscribers receive current content, while all are allowed to read older content supported by advertisements.

Given that I do not support some of the initiatives outlined in the New York Times article, does that mean I was content with the status quo? No, not at all. I recognize that the news media is a business. Thus, it must be profitable. The Dow Jones with its Wall Street Journal had been languishing for too long—in fact, that is the reason why the Bancroft family accepted Murdoch's offer. So change was inevitable, just a question of what and when. Myself, I would have preferred making the newspaper more informative and more insightful. I would have preferred to see more in depth articles. I am not sure how to translate those broad generic sweeping generalizations to something concrete. And perhaps that was the problem—those running the Wall Street Journal did not know how to make the appropriate changes either. So now we will have to sit and wait for Rupert Murdoch to make his changes.

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.

As those who follow my blog know, one of my hobbies is photography. As such, I follow and have invested in Canon Inc. (CAJ). During this past year, Canon has introduced two new professional cameras: EOS-1D Mark III, which retails for $4,495.95 at B & H; and EOS-1Ds Mark III, which retails for $7,999.95 at B & H. B & H is short for B & H Photo – Video – ProAudio. The first camera was introduced during the Spring and the second camera was introduced this Fall and began shipping only a few days ago. The demand for both cameras outstrips the supply. That is, if you want one of these professional cameras, you have to go on a waiting list.

Of course, these professional cameras require lots of memory. Moreover, they require large and powerful computers and disk drives to process and save the large image files. While I do not invest in many computer related technology stocks, I believe that the demand for these products is still healthy. And, as a side note, for those interested in learning more about these professional cameras and photography in general, I highly recommend joining Pro Photo HOME, an online photography site dedicated to the professional and serious amateur. The participants are friendly, knowledgeable and helpful—there is very little of the traditional internet noise.

While I think that the consumer slowdown will negatively affect camera sales, Canon's projections, available on the investor relations section of its website, still show healthy growth for the fourth quarter of about 13% by sales and 20% by units. Please note, although I discussed two professional cameras, the overwhelming majority of Canon's camera sales by units are point and shoot cameras. Digital SLRs (single lens reflex) sales by unit volume are a small fraction of the overall sales; however, they are more expensive and thus constitute a significant portion of the revenue.

As shown by this Yahoo's five year chart of Canon's stock price, the company shows reasonably steady growth. It has five main groups of products: 1) Office Imaging; 2) Computer Peripherals; 3) Business Information; 4) Cameras; and 5) Optical and Other. I do not understand the optical portion well, though it is one of the smaller groups. Camera sales constitute about 26% of Canon's overall sales and operating profit. The company is not widely followed in North America with only two or three analysts providing earnings and revenue estimates on Yahoo's financial site.

I have included some key statistics from Yahoo as of 5 December 2007:

• Market Cap (intraday): 68.43B
• Enterprise Value (6-Dec-07): 59.93B
• Forward P/E (fye 31-Dec-08): 13.80
• PEG Ratio (5 yr expected): 1.43
• Enterprise Value/EBITDA: 6.232
• Profit Margin (ttm): 10.96%
• Operating Margin (ttm): 17.12%
• Return on Assets (ttm): 11.12%
• Return on Equity (ttm): 17.14%
• Revenue (ttm): 39.89B
• Gross Profit (ttm): 13.31B
• EBITDA (ttm): 9.62B
• Beta: 0.67
• Total Debt/Equity (mrg): 0.008
• Current Ratio (mrg): 2.092

As the figures show, the company is conservatively financed. Overall, my general impression is that the company is well managed and provides excellent products and services.

Disclosure: I am long Canon stock.

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

This past Friday on CNBC's Fast Money, Karen Finerman chose Limited Brands, Inc. (LTD) as her final trade.

I recently purchased Limited Brands shares as well. A five year chart of LTD's stock price (Yahoo) shows that the stock has recently fallen from above $30 to the high teens.

Some key statistics from Yahoo Finance are as follows:

• Market Cap (intraday): 7.28B ;
• Enterprise Value: 8.99B;
• Trailing P/E (ttm, intraday): 10.27;
• Forward P/E (fye 03-Feb-09): 12.40;
• PEG Ratio (5 yr expected): 1.01;
• Enterprise Value/EBITDA (ttm): 6.731;
• Profit Margin: 7.07%;
• Operating Margin: 9.06%;
• Quarterly Revenue Growth (yoy): -9.10%;
• Beta: 0.88;
• Shares Short (as of 09-Nov-07): 19.79M;
• Short Ratio (as of 09-Nov-07): 3.7;
• Short % of Float (as of 09-Nov-07): 6.30%;
• Shares Short (prior month): 19.49M;

Looking at those statistics, I note that the sales growth has been soft—hence, the reason for share price fall—yet the valuation on traditional metrics appears reasonable. Moreover, according to a Barron's article Limited Brands a Black Friday Bargain (subscription required), even head honcho Leslie Wexner agrees that valuation has become intriguing.

Chairman and Chief Executive Officer Leslie Wexner was the biggest purchaser, buying 280,000 shares for $5.1 million, or an average of $18.31 a share between Friday and Tuesday. The purchases were made indirectly through a trust. In a filing with the Securities and Exchange Commission, Wexner said he plans to buy an additional 720,000 shares over the next eight trading days. Wexner now owns 51,642,179 shares, or 14.3% of Limited stock outstanding. It was Wexner's first open-market purchase in more than 13 years, according to InsiderScore.com.

The stock hit a four year low of $16.50 on Nov. 21, the day after the company announced third quarter income dropped 48% and cut its outlook for the fourth quarter. Limited reported third quarter earnings of $12.1 million, or 3 cents per share, down from $23.5 million, or 6 cents per share, a year ago. Analysts polled by Thomson Financial had expected Limited to post earnings, excluding items, of 1 cent per share.

All that said, with the softness in the economy because of high energy prices and falling housing prices, I would not be surprised if I am early in my purchase. I consider my purchase of Limited Brands stock an investment, one that might take 12 to 18 months to play out. If Limited Brands falls further, I might increase my position.

Disclosure: I am long Limited Brands stock.

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

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.

Blue Nile: Revenue and Earnings Estimates

Financial Metric	Current Qtr Sep-07	Next Qtr Dec-07	Current Year Dec-07	Next Year Dec-08
Data Sources	Yahoo Finance 5 November 2007
Revenue Estimates	68.02M	114.08M	321.75M	389.64M
Earnings Estimates	0.16	0.44	1.02	1.29

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

Revised Blue Nile: Revenue and Earnings Estimates

Financial Metric	Current Qtr Sep-07	Next Qtr Dec-07	Current Year Dec-07
Data Sources	Company press release and conference call transcript
Revenue Estimates	67.4M	109M – 115M	316M – 322M
Earnings Estimates	0.18	0.40 – 0.45	1.00 – 1.05

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.

Blue Nile: Key Financial Metrics

Financial Metric	NILE
Data Sources	Yahoo Finance, 7 November 2007 & Company Press Release
Market Cap.	$1.28B
Enterprise Value	$1.12B
Forward P/E (fye 31-Dec-08)	62.7
PEG Ratio (5 yr expected)	3.21
Enterprise Value/EBITDA (ttm)	53.978
Qtrly Revenue Growth (yoy)	26.7%

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.

The new royalty structure is largely a nonevent (see New Royalty Framework document (PDF, 950kb)). I expect that most oil companies have long term oil price projections of $55 to $65 WTI, with $55 being the more likely target. Companies are conservative by nature.

At $60, the terms are very nearly back to 1% gross revenue royalty and 25% net revenue royalty. So in terms of future development, the net effect should be muted. At higher prices, new entrants are discriminated against relative to existing players.

It is only at significantly higher prices that larger provincial takes kick in.

The markets, despite all the hoopla, have largely shrugged off this event. Suncor Energy Inc. (SU) and Canadian Oil Sands Trust (COS-UN.TO) were off less than 1.5% combined—easily within daily trading noise—yesterday, the first business day after Premier Stelmach's proclamation.

Some might think that these Suncor and Canadian Oil Sands were already down in anticipation of the royalty review. Not so, this link to a Yahoo price chart shows Suncor in U.S. dollars and Exxon Mobil Corporation (XOM) in U.S. dollars. You will note that Suncor has outpaced Exxon during the last three months. It did not tank prior to or after the Panel's published report.

Without crunching the numbers, a worthwhile exercise, I think the terms that existed during the mid 1990s were possibly harsher with the higher provincial and federal taxes that were about 50% higher than today's percentages. It is only under significant and sustained high prices, say $75+, that the new regime might be more punitive. And even that might be moderated going from synthetic crude oil to bitumen royalty regime. This entire last paragraph is intuitive guesswork that should be more thoroughly investigated.

With regard to the royalty percentages exceeding 25%, I would not be surprised to see the federal government cap royalty deduction at 25% of resource income. If that happens, then there will be a slight further hit to the oil companies. I remain skeptical that the federal government will offer to pay about 20% of the oil companies' increased royalties.

Given the final outcome, I am disappointed with the Panel's work. They had the opportunity to create a meaningful and workable royalty regime. Instead, they presented a wonky royalty regime with an oil sands separation tax, which was not tax deductible and extraordinarily difficult to pass politically. That combined with a royalty rate above 25% would have been very punitive on the oil companies.

After I think more about the Premier's new framework, I will likely comment further. I might even run some numbers through my economic models and discuss the comparisons. At present, however, I think the new framework is largely a nonevent.

I also urge you to read two other weblogs that discuss the new framework: WTF Journal by Ian Langdon and Ken Chapman by, you guessed it, Ken Chapman. My view differs from those of both writers. And that is okay. Blogging should be about informing. Our differing views will allow others to see arguments from different perspectives—a good thing.

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

In this article, I will briefly highlight major points raised in my prior articles. To help keep this article brief and easy to read, I will use bullet points throughout most of the article. If you want more depth, please read my individual articles leading to this summary. Please note that my summary will not necessarily follow the same order of the original articles.

 

Spacing added for weblog formatting purposes.

 

 

 

 

1. Royalty Review Terms of Reference
   • A quote from page 101 of the Report:

     An independent Panel of experts will review all aspects of the oil and gas royalty system, including conventional and oil sands. The Panel will also examine the tax regime faced by the resource companies, including income tax and freehold mineral rights levied on freehold mineral rights holders.

2. High Level Recommendations
   1. Prepayout
      • 1% gross revenue royalty.
   2. Postpayout
      • 1% gross revenue royalty (treated as a cost) plus,
      • 33% net revenue royalty.
   3. Oil Sands Severance Tax (OSST)
      • Starting at C$40 WTI, 1% gross revenue increasing by 0.1% for every dollar until 9% at $120 WTI.
      • Ineligible for payout calcuation purposes and nondeductible for federal and provincial taxes.
   4. Upgrader Credits
      • 5% of the capital cost for additional upgrader capacity in Alberta/
3. Did the governments and National Oil Sands Task Force (NOSTF) propose fair and equitable terms back in the 1990s?
   • While a thorough discussion of constitutes fair and equitable terms is a good exercise, let us for the moment assume that the governments and NOSTF did propose fair and equitable terms at roughly one third value to each of the following key project stakeholders: developer, province, and federal government.
4. Changes in tax rates since the mid 1990s
   1. In the mid 1990s, the federal rate, including large corporate surtax, was 29.12% and provincial rate was 15.5%.
   2. The federal rate will soon be at 18.5% and the provincial rate is at 10%. The provincial and federal tax rates were approximately 50% higher in the mid 1990s.
   3. If we accept that the sharing of the economic value pie was correct in 1990s, then the fiscal regime must be changed now just to reflect differences in taxation rates, let alone changes in commodity prices and other circumstances.
5. Resource Allowance and Royalty Rate
   1. Resource Allowance was set to 25% of resource income. Resource allowance has been replaced by actual royalty paid.
   2. If the province were to increase its royalty beyond 25%, the federal government is likely to cap the allowable deduction of royalty to 25% (back to resource allowance again) to preserve their portion of the economic value pie.
   3. By not having the federal government involved in the creation of a harmonious oil sands fiscal regime, the current proposal is likely dead on arrival. The federal government is unlikely to support a massive royalty increase, much of which will come at their expense unless the federal government caps the royalty deduction amount. Again, federal government is likely to cap the royalty amount as a federal tax deduction.
6. Support for Federal Elimination of Accelerated Capital Cost Allowance (ACCA)
   1. With ACCA, developers and engineers are more efficient in that they seek to spend the minimum amount of capital to address an issue; they will build infrastructure (capital expenditures) to address an issue because it reduces the project's ongoing operating costs.
   2. With the elimination of ACCA, developers and engineers are more likely to increase operating costs than spend capital dollars to address an issue because operating costs are more tax efficient; the downside is that higher operating costs increase the project's risk to a sustained downturn in oil prices or a sustained upturn in input costs.
7. Royalty Credits for Upgraders is Flawed
   • Royalty credits for upgraders are flawed because it does not consider the profitability of the developer. Imagine if oil prices were to hit all time highs, yet we citizens were subsidizing extraordinarily rich oil companies' investments in new upgraders. It makes no sense.
8. Royalty Based On Bitumen
   1. A bitumen based royalty is challenging because of the challenge of valuing bitumen and creating an open and transparent market for bitumen. Every project produces its own unique concoction of bitumen. All bitumen products from different developers with have different levels of fines (sand and clay), sulfur content, and other impurities.
      • Moreover, each upgrader is specifically configured to process its own feedstock. In other words, Upgrader Z values its feedstock differently than Upgrader Y would.
   2. A bitumen based royalty might kneecap future investments in upgraders when the current large heavy light oil differential disappears and upgraders return to being marginal investments. Upgraders are normally marginal investments. If, in the future, normality returns and a project requires an upgrader, it might be unable to proceed with the overall project because the cost of the upgrader is prohibitive and cannot be used to offset royalties. At present, a developer can elect to its royalty based on synthetic crude oil or bitumen. Because of the wide differential between light and heavy oil, a bitumen based royalty is preferred today.
9. Oil Sands Severance Tax (OSST)
   1. The Oil Sands Severance Tax is very punitive because it kicks in before payout and because it will harm new entrants most.
   2. Having a provincial OSST ineligible for the purposes of the royalty payout calculation and having it non deductible for provincial and federal taxes is poor policy
      1. It might discourage or delay developers from undertaking expansion, debottlenecking or efficiency projects.
      2. It might discourage or delay developers from undertaking additional environmental projects.
      3. It sets a poor precedent for taxation in Canada, giving Canada an unsavory reputation.
      4. Although not mentioned in the detailed article, what if the federal government wants to implement a windfall or carbon non deductible tax of their own? Should these windfall tax programs be coordinated between both levels of government?
   3. A challenge with burdening companies during good times with OSST, do governments come to the rescue during bad times?
10. Undiscounted Cash Flow Graphs for Comparison Purposes
    • In the report, the Panel showed various graphs for fiscal regimes around the world. These graphs, however, usually showed undiscounted cash flows. Perhaps that works well when comparing various conventional resources, but when comparing conventional and oil sands, it does not. Conventional production follows an exponential decline, meaning that most of the cash flow comes early in life, usually within the first ten years. Oil Sands have a steady or increasing production with time, meaning that much of its cash flow comes later in life, usually after the first 15 years. Thus, the sum of undiscounted cash flow charts will overstate the relative value received by oil sands companies.
11. Complexity of Proposed Regime
    • The new royalty regime is complex. The Panel proposed a 1% gross revenue royalty payable before and after payout. Post payout, an additional 33% net royalty is adjusted partially to account for the initial 1% gross royalty. In other words, the 1% gross royalty is treated as a cost in the post payout calculation. As mentioned previously, the OSST is an additional royalty or tax payment that is calculated and applied separately.
12. Open Process
    • I commend the Panel for putting the whole review process into the public domain. That is where it belongs.

I am critical of the Alberta Review Panel Final Report (PDF, 2.25mb). From my understanding, there does not appear to be a harmonious design between royalties and taxes. The Panel appears not to have considered the federal government's role in setting an overall fiscal regime. When it proposed provincial royalties beyond 25%, I knew that amount would be partially paid by the federal government, something that the federal government is unlikely to accept. At that point, I concluded that the Report was dead on arrival.

From there, I read the Report carefully and found other flaws, some of which are substantial. The Panel had the opportunity and, presumably, the resources to recommend a fiscal regime that would restore fairness to the citizens of Alberta and Canada. To act upon this opportunity in a proper fashion, the Panel needed to have broad wide ranging view. Instead, the Panel's view was rather myopic. It did not think through the implications of its design. It did not even bother to quantify the values to each of the major stakeholders, a fundamental act in any negotiation. Instead, it relied upon wonky international undiscounted cash flow summaries, which do not capture value well, and marginal effective tax rates, which are not effective measures when capital is returned to a developer in an expedient fashion. Moreover, the OSST has a host of issues of its own. In short, I believe the Panel's work is deeply flawed.

As an Albertan, I am disappointed.

Calgary model Judith Aldama is featured in the photograph, 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.