Can Blue Nile Return to Growth?

Implications

Blue Nile faces huge challenges in the fourth quarter, as well as, in FY 2009.  Here's why the Internet's biggest jeweler's growth may slow to a trickle.

Analysis

Analysts expect Blue Nile to report earnings per share of 16 cents for the 3^rd quarter according to Thompson Reuters.  That’s down about 9% from the previous year.  What they will actually report remains to be seen.  If you look at trends for the last two quarters and factor in a deteriorating economy both domestically and overseas analysts expectations seem high. 

Blue Nile’s annual earnings is less dependent on 4^th quarter sales than many bricks and mortar jewelry businesses.  Still, holiday sales account for between 43% and 46% of total earnings.  Last year the company earned about $0.45 per share in the fourth quarter on sales of $111.9 million.  The big question is can the company come close to that sales number this year given economic crisis.

In its favor is its pricing.  Blue Nile is clearly the price leader in large single diamond engagement ring sales on or off the Internet.  However, Internet sales growth has declined as the economy has slowed.   Some still think price conscious consumers will turn to the Internet to save both time and money this fall.  But that’s only theory, current numbers aren’t conclusive.  Anyway, those price point conscious consumers aren’t like to buy from Blue Nile which has some of the highest average prices in the retail industry.

While price leadership maybe work in Blue Nile’s favor this season, despite its high price points, declining diamond prices means the company will have to sell more units to equal last years turnover.  According to industry sources, rough diamond prices of both rough and polished diamonds are beginning to decline as the global economy deteriorates.  Since the DeBeers ‘Cartel’ was dismantled in 2001, diamond prices have been set more or less by supply and demand.  In general, large, better quality diamonds increased in price between 2001 and 2007.  Now, without the heavy hand of the “Cartel”, loose diamond prices are starting to behave like commodities which means deflation must be factored into any revenue calculation.  Add, lower gold and platinum commodity prices to the income equation and matching off to last years sales becomes even more problematic. 

Some pundits will counter that lower prices will stimulate demand.  That’s probably true in the long term, but prices will likely drop faster than demand decelerates in the short run.  This brings us to the Blue Nile’s next advantage, its low cost structure.  With only about 191 employees and little inventory, the company is a low cost provider of services, but it has very low margins too.  So its profitability is highly sensitive to both average price and units sold.

Should Blue Nile’s sales volume decline because of low demand and its average price falls because of lower diamond prices, about the only material cost the company could cut is its marketing expenditure.  Unfortunately, e-commerce businesses behave more like direct marketing enterpriser than traditional retailers.  Sales are proportional to the prospective advertising expenditure and there isn’t any sign that the cost per new customer is falling in spite of the economy. 

E-commerce businesses like Blue Nile have been viewed in terms of a continuous growth scenario.  From 2001 to 2007, both units sold and average prices frequently increased double digit annually.  That growth was a consequence of cheap credit with drove sales and access to relatively inexpensive capital which made new business investment and innovation possible.  Now free standing Internet sellers have to prove they can be profitable in a deflationary environment where prices decline and capital investment is limited.  Whether Blue Nile will be on of those companies is problematic at best.