Blue Nile Struggles Amidst Luxury Industry Collapse

MasterCard’s SpendingPulse recently reported that the 34% decline in sales of luxury items was the highest year-on-year decline of any retail category during the holiday season and that the reduction was led by falling jewelry sales. In such conditions, it is not surprising that Blue Nile (NILE) recently announced a lackluster Q4 performance.

Q4 revenues of $85.8 million were significantly lower than the Street’s estimates of $92.2 million and recorded a 23.3% reduction over the year. EPS of $0.24 also fell short of the market’s expected $0.34 and recorded a significant 47% decline over the year. For the year, revenues fell by 7.5% to $295 million. EPS of $0.75 were down 28% over the year.

According to a comScore survey, online jewelry sales dropped by 12% in 2008. In comparison, Blue Nile’s dropped 7.5%, which does imply an increase in market share for the company.

Total orders declined by nearly 20% and the average order value decreased 3% to $1,370 in the fourth quarter. By region, US sales fell 24.6% and international sales were down 4.2% in the quarter, primarily driven by the strengthening US dollar. For the year, engagement jewelry sales accounted for 69% of revenues compared to 68% a year ago. The average price of an engagement ring fell marginally to $6,000 from $6,200 in 2007 but continued to remain significantly above the US average of $3,200.

During the quarter Blue Nile repurchased 31,400 shares for $1.2 million. For the year they purchased 1.6 million shares at a total cost of $66.5 million.

The growing recessionary pressures have resulted in a reduction in retail jewelry capacity. In the United States, there was a 5% decline in the number of jewelers. The traditional brick-and-mortar retailers are highly leveraged and as such cannot sustain a long recession. The conditions have already resulted in a few jewelers succumbing to bankruptcy this year. As the industry consolidates, it opens up additional opportunities for the relatively low fixed cost, low inventory and low capital requirement model on which Blue Nile operates.

Additionally, diamond prices have started falling after rising over the past few quarters. Since Blue Nile has always focused on optimizing inventory levels, they will be able to benefit more from this decline than traditional jewelers who normally hold a larger inventory. During Q4, Blue Nile managed to reduce their inventory levels by 10% over the year.

For the coming year, besides the cost control measures found in just about every company, Blue Nile is focusing on two key initiatives. First, they aim to continue to improve their customer experience through improvement in web site functionality, product visualization and customer features. I have repeatedly mentioned how they need to improve personalization on their web sites. Though they did not divulge the measures they are adopting for the improvement, hopefully personalization will be one of them.

Second, Blue Nile plans expansion into international markets. In 2008, they expanded their shipping capabilities to over 35 new markets in Europe and Asia Pacific, and increased their international sales by 62.9% to $27.7 million. They plan to improve international customer experience through currency localization and product assortment.

BlueNile is one of my preferred Internet stocks. Their fundamentally strong business model is their biggest asset. The current market pressures are causing them some heartburn, but as I said earlier, this might just be the time to address their up-sell and cross-sell challenges driven by better web site functionality and personalization.

The stock is currently trading at $25.75 with a market capitalization of $373.30 million after having recovered from the five-year lows attained earlier last year. Things will continue to be difficult for a while for the company, so I don’t necessarily recommend buying the stock for the time being.