Blue Nile Faces Bigger Challenges Than Higher Diamond Prices

Implications: Investors may be underestimating Blue Nile's real challenges in the second half.  Here's why.

Analysis: In spite of sales declining in their primary market, Blue Nile stock increased over 10% by noontime Monday.  Trading at $49.40, the stock had gained $4.40 per share after it announced a sales increase of 2% and a 15% decline in earnings last week.  

All of Blue Nile’s growth came from its overseas markets.  US sales actually declined about 5% in the quarter.  Moving forward, Blue Nile’s management revised it 2nd half sales estimates from about 10% to low single digits.  According to the company, the revision was because of higher diamond prices.  However, I suspect the reason has more to do with the weakening of demand in the UK and Europe which will materially effect Blue Nile's growth overseas.  

While it is true large, high quality loose diamonds have increased in price.  That’s not new. The fact is this type of diamond has increased by mid to high single digits for most of the last decade.  That’s made them more attractive to affluent buyers who often view such large jewelry purchases as a passive investments as much as a symbol of status and prestige.   

What should concern investors more is the deteriorating economies in the UK and Western Europe where Blue Nile does most of its international business.  A slowdown there means the company will loose what little growth it is currently achieving, as well as, do even worse in its primary market North America.  That’s because as international economies weaken, the growth companies like Blue Nile are achieving because of a weak US dollar and tourism will plummet.  

In theory a stronger US dollar should be good for domestic economy as lower oil prices demonstrate.  Unfortunately, the current strengthening of the dollar is a consequence of weakening overseas economies rather than a reduction of the structural barriers to growth that have existed in the US since the mid 1990’s.  

With credit still tight, the mortgage fiasco continuing, home equity withdrawals limiting consumer liquidity, basic food and energy prices increasing, and overseas economies weakening, Blue Nile’s future is dim at best, and bleak at worst.   Selling for over $100 per last year, Blue Nile was priced as a high tech, e-commerce, growth company.  Selling at a 48X multiple, it is still priced for growth, but it remains to be seen just where it will grow and just how high tech the company really is.