Until now, Blue Nile has been largely invincible to the cycles affecting other jewelry retailers. Further, its business model has caused heartburn for store-based jewelers, and its ability to capture market share has been the envy of the industry.

 

In the third quarter ended September 2008, this seemingly invincible merchant finally stumbled: U.S. sales were down by 7 percent and corporate profits dropped by 21 percent. In October, things worsened substantially for Blue Nile: total corporate sales fell by 20 percent; this includes both the U.S. and overseas markets. We estimate that Blue Nile’s U.S. sales fell by 22-24 percent in October.

 

While the sales and profit comparisons for Blue Nile are disappointing, they are still well ahead of others in the industry. Compared to other store-based merchants, Blue Nile’s third quarter sales trends remain among the best which have been reported so far. In contrast, Finlay’s same-store sales were down over 13 percent and Sterling’s same-store sales fell by nearly 8 percent. Further, our sample of independent jewelers’ sales shows a wide disparity in revenue comparisons, but at least four out of five in the sample universe confirm that sales are running well below last year’s levels, with some jewelers reported that sales are off 40 percent.

 

Further, ComScore reported that U.S. online jewelry sales were down about 11 percent in the third calendar quarter. Thus, Blue Nile’s results – a decline of 7 percent in the U.S. market – confirm that the company gained market share versus other online jewelry merchants, if we believe ComScore, a sometimes dubious source of data.

 

While Blue Nile has proven that it is not immune to the same ills that affect other jewelers, its results continue to confirm that its business model appears to be superior to the typical jewelry merchant’s business model. Sure, Blue Nile’s sales are down, but not by as much as its competition. And most importantly, it posted a solid, though diminished, profit in the third quarter, a period when almost all other jewelers lose money.

 

The following table summarizes Blue Nile’s financial results for the third calendar quarter ended September 2008.

 

 

 

Third Quarter Highlights

The following are highlights from the company’s third quarter.

 

• Total revenues declined by 2.9 percent in the three-month period ended September 2008.
• U.S. sales were down by 7 percent, continuing a trend of declines that began earlier this year.
• Overseas sales were up 53 percent, a notable number, but down dramatically from the 179 percent gain posted in the second quarter.
• The number of orders fell by 6 percent during the third quarter.
• The average ticket rose by 3.1 percent to $2,159 in the three-month period.
• During the quarter, sales comparisons were worst in late September.
• Sales of jewelry priced above $100,000 retail and in the range of $5,000 to $25,000 were the weakest categories. Jewelry in these two price ranges are “aspirational” categories for certain types of customers. However, sales of merchandise priced below $5,000 and between $25,000 and $100,000 rose in the quarter.
• Management said that it had not seen a decrease in the number of credit approvals in the quarter. However, it noted the exact opposite in the second quarter, when management said that credit approvals were down. We believe that Blue Nile’s credit sales mix is down.
• During the quarter, Blue Nile introduced “Bill Me Later” – an interest-free 90-day program – in an effort to build its credit sales business.

• Blue Nile’s October sales declined by 20 percent. Management did not provide a break-out of sales by market, but we estimate that U.S. sales were down by 22-24 percent while overseas sales were likely up by 30 percent or so.

• The strengthening U.S. dollar hurt overseas sales in the third quarter. Currencies in markets that Blue Nile serves fell by about 20 percent in the three-month period.

• Polished diamond prices – among the categories of diamonds that Blue Nile sells – were up about 20 percent in the quarter. This compares to a 14 percent gain in diamond prices for all categories, third quarter year-over-year, according to the IDEX Online Index of Polished Diamond Prices. Clearly, Blue Nile’s sales mix includes a greater proportion of larger, better quality diamonds where price increases have been above average.

• Blue Nile apparently uses a combination of industry price lists and vendor invoices to determine its retail prices. After one industry diamond price list artificially raised prices significantly in May, Blue Nile raised its retail diamond prices. This move apparently caused some slowdown in sales at Blue Nile, because it price-based competitive differential was not as compelling when compared to store-based jewelers who did not raise their retail prices. We believe that Blue Nile may be reviewing its retail pricing strategy.  

• Here’s what’s important: because Blue Nile does not maintain a significant inventory of diamonds, it must pay market prices at the time it makes a sale. In contrast, a store-based jeweler typically owns most of his/her diamond inventory. In periods of rapidly rising polished diamond prices – such as we’ve seen this year – Blue Nile operates at a disadvantage to store-based jewelers. However, as polished diamond prices begin to fall – a trend we’ve seen recently – it will gain a pricing advantage over store-based jewelers who own their inventory at significantly higher cost.

• Management cited the current economic turmoil as a key factor that hurt its sales gains:
• Consumers’ homes are no longer an ATM machine with an endless supply of cash.
• Consumers’ stock market gains – that consumers previously spent – have now evaporated.
• Credit card limits have been reduced for many of Blue Nile’s shoppers.

• Blue Nile’s holiday sales strategy is interesting: it plans to increase the number of new merchandise introductions over a wide range of price points. The company will offer more pearl jewelry and increase its offerings of colored gemstone jewelry. In contrast, we believe most other merchants are cutting back on offerings and inventory levels. If Blue Nile’s strategy works, it will prove – or disprove – the theory that consumers want “newness”; if Blue Nile offers something new, exciting, and different, its fourth quarter sales should reflect strength (even if they decline) that we won’t see in other jewelers’ results. This upcoming holiday selling season will be a real test of the company’s merchandising expertise.

• Blue Nile management said it plans to shift its merchandise mix to lower price points during the current economic weakness. This reflects consumers’ desire to “shop down” to lower price points for their jewelry.

• Management said demand for engagement jewelry was weaker than non-engagement. We have seen no slackening in the number of marriages in the U.S. market, based on the latest government data. However, anecdotal data suggests that bridal spending has been reduced during 2008.

• Blue Nile said its ability to buy online advertising space (banner ads, for example) has improved this year. Many online and store-based merchants have cut back on their online marketing budgets, so there is an inventory of available marketing opportunities for those desiring to advertise online.

• Blue Nile acknowledged that its inventory levels were up, but said most of these goods were settings and other basic jewelry. It dismissed questions from analysts who suggested that these rising inventory levels could be detrimental to the company’s financial results later this year and perhaps into 2009.

• Blue Nile is having no trouble obtaining merchandise, despite a credit squeeze which has affected many jewelry suppliers. Blue Nile is one of the few companies which is flush with cash, and it typically pays its bills according to vendors’ terms.