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Tuesday, February 16, 2010

Blue Nile Begins to Fall Out of Orbit - Valuation Remains Rich; Offers No Safety

We wrote in December that insiders at Blue Nile (NILE, $49.11) were smartly taking advantage of the company's rich valuation (please see our October post) to unload personal holdings in the high $50s and $60s. Sales continued in January and February (from Yahoo! Finance):

Last week, the company reported results and guidance that fell short of consensus estimates (reported by numerous media outlets, including this AP article). This Reuters article also noted that results missed recent bullish commentary from Blue Nile's CEO:
  • "Expectations had been high for the Seattle-based Web retailer after bullish comments in recent months from Chief Executive Diane Irvine, who had said December revenues were projected to rise 26 percent."
Year-to-date, the stock already trended lower and then gapped down last week after the news:

Despite the Market's disappointment, results were respectable -- headlines from the release:
  • Reports Fourth Quarter Net Sales Up 20% to $102.9 Million
  • Non-GAAP Adjusted EBITDA Increases 38% to $10.6 Million
  • Full Year Non-GAAP Free Cash Flow Grows to $36.7 Million
Yet, as noted in our prior posts, it all comes down to valuation: expectations were extremely high and Blue Nile's valuation already gave credit for significant future growth. Even now, shares continue to trade at 40 times this year's estimated consensus earnings (and 19 times TTM free cash flow). For a forward valuation view looking out a few years, please see our summary model included in our October post. Although full-year 2009 results came in slightly higher than our October estimates -- implying higher out year financial results -- valuation multiples remain high and, in our view, suggest future multiple compression as Blue Nile "grows into" its current valuation. We see something similar happening to Amazon (AMZN, $117.53) -- note recent sell-off -- which also happens to be trading at 40 times this year's consensus earnings estimate (but only 17 times TTM free cash flow). By contrast, PetMed Express (PETS, $19.74) -- which we own and discuss here -- is trading at only 16 times forward earnings (but 17 times TTM free cash flow).

We continue to favor unloved, low P/E and/or low P/FCF multiple merchandise such as 1-800-Flowers.com (FLWS, $1.89 - post last week here) and Bidz.com (BIDZ, $1.93). The latter's business model is far more discretionary than Blue Nile's engagement ring centered model and conditions remain difficult, yet we believe things can get better for the company. Plus, we have protection from low multiples with plenty of room to expand whenever fundamentals turn and the Market takes notice.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long PETS, BIDZ, FLWS.
© 2009 Jeffrey Walkenhorst
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