Marathon Asset Sells Blue Nile Down the River

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

It appears the sparkle of the online jeweler Blue Nile (NASDAQ: NILE) is beginning to dull in the eyes of Marathon Asset Management. Per a recent SEC filing, Marathon cut its position in the online retailer to just over 615,000 shares, or 4.92% of Blue Nile's outstanding shares. 

This is a big change from the 1.69 million shares that Marathon owned at the end of the third quarter. It appears that Blue Nile's over-valuation might well be at the heart of Marathons' sell thesis. The stock is trading near 60 times trailing earnings, which is above historical levels; what's more is that the earnings growth doesn't appear to support a premium multiple (check out all the stocks Marathon owns here).

Blue Nile is a jewelry focused ecommerce company, a business model that has been very fruitful for a number of companies, including Amazon (NASDAQ: AMZN)However, it is not Blue Nile's ecommerce business model that I take issue with, it's the jewelry business in general. 

Competition for the industry is flush, where Zales and Sterling actually lead the retail segment with respect to store number. Surprisingly enough, or maybe not so surprising, is that Wal-Mart leads the retail jewelry segment in sales, generating some $2.75 billion from jewelry sales. The other major competitors all came in with an estimated $1.4 billion, this includes Sterling, Zales, Macys and Tiffany's (NYSE: TIF)
Blue Nile's CEO believes there is little to worry about concerning competition, stating that...

The 150,000 diamonds that we have on our site, the 20 to 40 percent price differential between traditional brick and mortar stores and what we bring to market helps to re-ignite our business success and really grow.

I tend to respectively disagree. The number of stores already in the market might not scare Blue Nile, but what they are doing should. These retailers have been offering lower-cost products, even at the expense of its margins, which could well continue to take market share from Blue Nile. The need to compete has put steady pressure on both Amazon and Blue Nile, as exhibited by a decline in profit margins: 
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Although Amazon has faced margin compression, the ecommerce company managed to take advantage in 2009. The jewelry segment was hit hard in 2009, including Neiman Marcus (jewelry segment sales down 27%) and J.C. Penney (down 24%), but Amazon managed to boost its jewelry segment sales 13%. Amazon's company-wide sales are expected to be up 28% in 2013, driven by continued market share gains from traditional retailers.

The benefits of ecommerce and shopping at home has put strains on the likes of major brick-n-mortar retailers. The convenience and savings of shopping online is undeniable, where 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%. Many investors may also find reason for concern related to Amazon's forward price to earnings multiple of 160 times, but the e-commerce company has a much broader product offering than Blue Nile, one that includes almost any imaginable item. As well, Amazon has other initiatives, including Amazon Prime and its Kindle Fire that are playing key roles in inspiring larger and more frequent purchases. 

While Amazon has managed to convince consumers that it is safe to purchase TVs and computers online, I still see the same type of jewelry market reshaping as being much more difficult. Something as meaningful and lasting as a piece of jewelry, namely an engagement ring, is generally a sizable purchase that should remain an in person experience. For investors looking to get some exposure to the higher-end consumer markets, Tiffany may well be the best bet. Recent sales numbers showed strength for the holiday-season (Nov.-Dec.), where the retailer saw same store sales growth of 7% in its Asia segment, and the company expects to post 4% company-wide sales growth in fiscal year 2014 (ending Jan.).

Don't be fooled
During the two instances that Blue Nile's P/E has risen about 60 times over the last five years, the stock returns to a more normalized trading range of 35 times to 45 times: 

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I tend to agree with Marathon in the respect that Blue Nile may be ahead of itself and now could be a good time to take some money off the table. Even on the high end ($0.75 per share) of Blue Nile's recently released 2012 earnings guidance, where full year 2012 EPS is expected to come in between $0.70 to $0.75, the stock appears to be fairly valued. This assumes a 45 times P/E multiple on 2012 EPS estimates, where the 45 P/E is both the industry average and a normalized company P/E. In fact, Blue Nile has traded three times the S&P's price to earnings ratio on average for the last five years, and now the stock is trading at 3.8 times (check out all the hedge funds loving Blue Nile). Billionaire Ken Griffin is another big-name investor that has also been dumping Blue Nile. Griffin sold off 89% of his shares during the third quarter and now owns less than 100,000 shares (check out what Griffin traded in Blue Nile for).

mhargra has no position in any stocks mentioned. The Motley Fool recommends, Blue Nile, and eBay. The Motley Fool owns shares of, eBay, and Tiffany & Co.. 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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