Summary
Does Deutsche Bank know something about Blue Nile no one else does? Maybe, but Blue Niles' problems are no secret. Here's more.
Analysis
What does Deutsche Bank’s Herman Leung know about Blue Nile that everyone else doesn’t? Obviously something, otherwise he wouldn’t have downgraded Blue Nile to a “sell” and cut its target price to $18. On the other hand, he may not know anything new and simply be setting up Blue Nile as the next great short. Speaking of which, about 28% of Blue Niles' 5 million share float is already sold short. Still, prospective investors have to ask why the company sells at 49X earnings in the current economy. Let’s face it the company has a lot going against it.
For instance, luxury sales, especially fine jewelry, continue to be weak even for the uber rich. Moreover, jewelry demand by young, aspirational shoppers has declined even more since September 15, 2008. Yet, the company points out that its International jewelry sales are growing and that the marriage market is strong. Both true, relatively speaking. But realistically, Blue Niles' overseas large diamond sales aren’t growing fast enough to make up for the company’s sale declines domestically and aspirational jewelry buyers are shopping the Internet less and trading down during the recession. According Leung, Blue Nile has reported their page views have declined. That’s in keeping with year over year Internet jewelry business in terms of sales, page views, and conversion rate.
Longer term analysts say lower diamond prices will improve demand. Maybe, but it’s problematic whether higher unit sales, if any, will offset the decline in Blue Nile’s average price. Then there’s the emotional issue about diamond value. Clearly demand for diamonds and their emotional connection with consumers are inexorably linked to value. “A diamond is forever” is a tag line that uniquely
resonates with diamond buyers, especially engagement ring buyers, in a complex way. Lower prices in combination with the recessionary economy could actually mean fewer diamonds sold.
Before the recession, Blue Nile’s founder was touting the companys' growth potential. Then he expected Blue Nile to achieve about $800 million is sales before 2015. With annual sales of about $300 million and current growth negative, those expectations seem more unrealistic now than they did then. In fact, with industry growth over the next half decade likely to be very small, the question is: Where will Blue Nile’s growth come from? After all, in this environment, growth is all about market share management and it remains to be seen whose market share Blue Nile can steal.
Lastly, as both vendors and bricks and mortar jewelers restructure their costs, Blue Nile’s low price offer may come under direct attack as the industry adjusts to the consumer’s emerging expectations for high value, utility, and functionality. That will erode much of Blue Niles’ momentary competitive advantage. So maybe Leung does know something everyone else doesn’t. At the very least, short sellers may be the only long term winners for Blue Nile.
