Summary
Blue Nile's wasn't the first company to try to reinvent the retail diamond industry. Here's why changes in the consumer and in the diamond pipeline will be their eventual undoing.
Analysis
It wasn’t that long ago Mark Vadon was saying Blue Nile would reach $800 million in sales in 3 to 5 years. Now, it’s problematic if the stock will achieve 2006 sales levels as the high end diamond markets contracts. Still, the stock is selling for 20X earnings and about 18X book value. That’s a pretty hefty valuation considering its bigger jewelry competitor like Tiffany is selling only 9.0X earnings.
Granted, Blue Nile has the advantages of low overhead and even lower inventory, which should insulate the company’s earnings as sales declines. But with luxury jewelers reporting sales declines greater than 30%, Blue Nile’s top line sales is the real problem because of what is happening in the diamond market and its lack of product diversification. For instance the price of rough diamonds has all but collapsed and the polished diamond markets aren’t far behind. That means all $5,000 engagement rings and 3-stone rings that Blue Nile sold could be worth 25% to 35% less now.
That may not be a big deal, since they weren’t purchased as an investment anyway, but it does mean prospective customers are likely to wait to buy the “Big” rock until prices bottom out which isn’t likely to happen soon. The combination of less demand and lower price points means big trouble for Blue Niles’s top line.
Long term the company could benefit from lower prices as the economy emerges a recession that is shaping up to be the worst since the Great Depression. All things being equal, lower prices should mean increased demand. But all things aren’t likely to be the same. First, leading economists believe it will years before the economy returns to robust growth and then it’s almost certain consumer attitudes about conspicuous consumption will have permanently changed which may undo much of what DeBeers’ marketing achieved over the last 50 years to build demand for diamonds.
Then there is the narrow product mix. Blue Nile’s focus on expensive, large diamond bridal jewelry was clearly strength during the easy money, cheap credit decade that preceded the recession; but, now high price points and narrow product offer will likely restrict the company’s sales growth. Lets’ face it neither Mark Vadon nor Dianne Irving are merchants. Blue Niles’ success was never a merchandising play, but a low cost gambit driven by 20% margins. Now the dynamics of that profit model has changed eroding much of the company’s competitive advantage. For instance, most of Blue Nile’s large diamond inventory has been on consignment. Now that may have to change as many large diamond cutters are closing shop and mine owners trying to reduce the over supply of diamonds in the market. That means Blue Nile may have to invest in a lot more inventory or look a t reverse integration to maintain continuity of supply of large loose diamonds. Both would mean higher margins.
Blue Nile’s top line sales will also suffer because of the company’s narrow product mix both in terms of price point and product variety. Unlike an online company like Amazon that appeals to the mass market, Blue Nile appeal is much narrower, that will limit their sales during the recession. Whether the Vadon-Irving team has the merchant’s skill to be “Real” retailers remains to be seen.
Blue Nile’s future would be uncertain if its problem was only the economy. But, add changes in the diamond pipeline, narrow appeal, declining growth in Internet sales, and changes in consumer buying behavior, you have a high risk and potentially volatile company where the downside looks disproportionately large when compared to any upside value.
