Which Diamond Is forever?

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The jewelry market is largely dominated by three companies: Tiffany & Co (NYSE: TIF), Blue Nile (NASDAQ: NILE) and Zale (NYSE: ZLC). Due to the global economic recession and resultant decline in consumer disposable income and confidence, these companies experienced declining sales and margins. However, one company that shown bright even during these times was Blue Nile, which posted 2% and 10% sales growth in FY09 and FY10, respectively. 

As the economy improves, there is a gradual improvement in sales growth. Zale has experienced declining sales and negative profit in the last 4 quarters except for 2Q13 when its net income jumped 42%. Similarly, in January 2013, Blue Nile posted a 4Q12 net sales increase of 21.2% and net income increase of 17%. However, in contrast, Tiffany & Co  posted weaker 3Q12 results with sales increasing by a hair's breadth of 1% and net income declining 30%.

What drove Blue Nile during the recession was its business model. Blue Nile is the world’s largest online retailer of certified diamonds and fine jewelry. The company used the strategy of providing high-quality diamonds and jewelry at attractive prices as well as educating its customers with respect to in-depth product information, grading reports, and trusted guidance throughout the purchasing process.

The comparison between Blue Nile and Zale is unusual given that each has a different operating model –  Blue Nile is an online retailer while Zale is a typical bricks-and-mortar store. Despite this difference, Blue Nile trades at a whopping P/E of 55.39, higher than even Tiffany's P/E of 21.11. Let us delve further -

Sales:

  • Although Zale has high absolute sales value, the growth rate is much lower than that of Blue Nile. While Blue Nile posted positive sales growth in 2009 and 2010, Zale posted negative sales growth in both the years.
  • Blue Nile's sales have been consistent over the past 5 years with a CAGR of 6%.

Margins

  • Although Blue Nile posted a gross profit margin of 20%, it has been able to post average 5% margins in the last 5 years. On the other hand Zale has a gross profit margin of 50%, but has positive margins in only 2 out of 5 years.
  • Given its lower profitability, Zale Corp has a negative Return on Equity of 5.6% vs. Blue Nile's double digit positive return (34%).

Cash flows

  • Blue Niles cash flows have been stable and have mainly been used for share repurchases.
  • Zale Corp has posted negative operating cash flows in the last two years. Capital expenditure is higher vs. Blue Nile due to its bricks-and-mortar model. Further, post FY08, the company discontinued its share repurchase.

Balance Sheet:

  • Blue Nile has been able to maintain a steady cash balance, averaging $85 million. Further, its balance sheet is debt-free.
  • Zale Corp's cash balances have declined by 60%, from $61 million in FY08 to $24.6 million in FY12. It has a Debt/Equity ratio of 244.4. Its Debt/EBITDA ratio improved to 7.3x only due to its strong 2Q13 results vs. FY12 Debt/EBITDA ratio of 8.0x

Share Price:

  • As seen in the adjacent chart Zale Corp's share price has been fairly volatile. Though in the last one year share price has increased 30%, it is still trading 50% below its 52-week high of $7.
  • Blue Nile on the other hand did experience a downtrend in the beginning of the year but its share price has moved in a fairly stable fashion, trading at mid level of its 52 week range of $22-$43.
  • Similarly, over 5 years, Zale Corp's share price has declined almost 79% vs. 17% decline in Blue Nile's share price.

Conclusion:

The convenience and savings of shopping online is undeniable and Forrester Research projects that U.S. e-commerce sales will increase from $202 billion in 2011 to $327 billion in 2016, an annual growth rate of 10.1%.
Zale reported an astounding 2Q13 but whether it will be able to maintain this momentum only time will tell.
It is true that the company is trading at a premium of ~55 times its earnings with earnings growth not supporting the  premium multiple. However, given Blue Nile's stable sales growth and margins supported by a strong and debt free balance sheet, I would recommend this company for the long haul.


Shas Dey has no position in any stocks mentioned. The Motley Fool recommends Blue Nile. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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