Why You Shouldn't Buy Blue Nile Today

Don't say I didn't warn you about the dangers of online diamond retailer Blue Nile (NAS: NILE) . I have warned -- on no less than six separate occasions over the past year -- that Blue Nile was losing its luster and that shareholders would be wise to take notice of it. The 35% gain on my CAPScall of underperform as of this morning is even more evidence of this.

Last night those fears were once again realized with Blue Nile shares tumbling in after-hours trading following its fourth-quarter results. The company reported a profit of $0.30 on a 2% decline in sales to $112.3 million. Both of these figures were miles away from the consensus estimate for a profit of $0.42 on $123.2 million in sales. To make matters worse, Blue Nile forecast first-quarter EPS will be in the range of $0.04 to $0.07 on sales of $81 million to $84 million. Wall Street had been expecting a profit of $0.17 and revenue of $86.3 million.

The problems that Blue Nile alluded to are all the same concerns I've expressed in the past.

For starters, commodity price increases are crimping the company's margins. Blue Nile doesn't use very much of its cash on purchasing its diamonds. Instead, the company chooses to purchase them from a Rappaport list once its customers have made the decision to buy. Since diamond prices have risen a clean 75% in just the past six years, this puts Blue Nile at the mercy of current market prices which are -- you guessed it -- at a six-year high.

Blue Nile's inability to control its pricing is also killing the primary allure of the stock -- its comparative advantage. Let's be clear here; Blue Nile isn't "losing" its comparative advantage... it's flat-out gone! Mall-based retailers Signet Jewelers (NYS: SIG) and Zale (NYS: ZLC) , while not exactly lighting it up, have fared much better than Blue Nile because the majority of their purchases are being negotiated in advance. This gives them the flexibility to adjust their prices as needed to drive sales which is a luxury that Blue Nile simply doesn't have right now.

Blue Nile also alluded to weakness in high-end diamond sales, which is something I had not anticipated. Worst of all, this seems to be confined just to Blue Nile. Tiffany (NYS: TIF) , which admittedly has suffered from its own struggles, still reported a 4% rise in same-store sales for the holidays.

The only saving grace I can see here is the $100 million share repurchase that the company announced along with its year-end results.

Blue Nile also commented that it was in the process of transitioning away from being a pure engagement play and that it saw 15% customer growth as a result of its broadening focus. Personally, I think this move is long overdue. As someone who personally worked in the jewelry industry for a decade, I've seen very few engagement-only companies survive. Keep in mind, though, that this transition isn't going to be completed overnight and there are still many years of hiccups to come.

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Blue Nile is a mess, and despite today's drop, it's still not even close to being cheap. The company has completely lost the luster that once made it a darling of Wall Street. Now, all that's left are a smattering of inclusions that are quickly bringing down its valuation.

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At the time thisarticle was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He has successfully passed a diamond grading course offered by GIA. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Motley Fool newsletter services have recommended buying shares of Blue Nile. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 that's always flawless.

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