Question & Answer: Using the annual report from the company that you have selected for your Final Project ( DOLLAR GENERAL) , discuss the risks the company f…..

Using the annual report from the company that you have selected for your Final Project ( DOLLAR GENERAL) , discuss the risks the company faces and the actions they take to mitigate those risks. Refer to the Management Discussion and Analysis section of the annual report for this information.

As part of your response consider whether you think the risk mitigation techniques are reasonable. Discuss what others concerns or advice you would offer if you had the opportunity.

Include in your post a calculation for the probability of one of the risks identified by your company. This information may not be available in the annual report, therefore you will likely need to conduct research and critical thinking to complete this calculation

Expert Answer

 

Blue Nile, Inc.

The company I’m researching is Blue Nile, Inc. They were incorporated in 1999, and operate as an online retailer for high quality diamonds and fine jewelry. They operate under the ticker symbol NILE. The specialize in marketing jewelry in the engagement and non-engagement categories with shipments made both in the United States and Internationally. Their primary marketing differentiation is an online ability for the customer to design their own ring. Cost efficiencies are obtained through an arrangement with the diamond wholesalers allowing Blue Nile to display diamonds that are owned by the wholesalers and that only become a cost of good once the order is placed. Final products are made and delivered using a just in time inventory fulfillment along with seven day customer delivery as the standard processing option (Blue Nile Inc., 2012).

Identified Risks

The Blue Nile 10-K contains the usual list of general business risks. Concerns such as security breaches, unsuccessful brand development, failed product extension, weather events, foreign currency exchange rates, unanticipated taxes, and unforeseen restrictive regulations are all well covered in the categorization of risks (Blue Nile Inc., 2012). However, also contained in these general risk assessments are three risks that appear unique to the business.

The first is an explicit declaration that as a result of seasonal fluctuations in net sales, the quarterly results may fluctuate and could be below expectations (Blue Nile Inc., 2012, p. 8). The 10-K goes on to describe typical jewelry holidays such as Valentine’s Day, the general wedding season, and Christmas. The stated risk is that these unusually high sales periods might have a negative impact on people and process capacity along with a strain on the supply and fulfillment process. I find this discussion of risk to be very disconcerting relative to the management team. If you are going to build a high end jewelry retailer you would expect these seasonal swings and design the company appropriately. Stating the risk as a net-negative rather than stating that the system has been designed to handle seasonality, but might under estimate the demand load gives the appearance of a weak management team. This risk should easily be mitigated by researching high end jewelry seasonal sales volumes and building the processing system to handle the larger rather than the smaller volumes.

The second risk is interesting as it builds on the first concern of the management team and their capabilities. This risk is stated as, “we may not accurately forecast net sales and appropriately plan our expenses” (Blue Nile Inc., 2012, p. 11). It is very interesting that the risk is expanded to state that they may not accurately forecast the net sales and operating results. I find it intriguing that the company sees an inability to predict a net figure as a problem. Traditionally management would forecast top line revenue and then expenses as an operating percentage of that revenue. A more typical statement of risk would be that the company might over estimate the sales projections or fail to accurately forecast all expenses of operation. But, it seems unusual to focus risk management on a net calculation. This would be mitigated by conducting a thorough financial analysis and building pro formas for the company operation based on past history and industry trends.

The third risk in this focus is also a contributor to the management capability. The state as a significant risk, “we may have exposure to greater than anticipated tax liabilities” (Blue Nile Inc., 2012, p. 13). Again, this sheds light on a potential management challenge. As an online retailer with no physical presence the potential tax liabilities should be limited to sales tax, property tax on warehouses, and income tax. Even though this is an international company there are plenty of groups that capture tax rates. Rarely do tax rates move in a given year without prior notification. Even granting lack of notification a percentage move in a tax rate should not be a significant driver for earnings per share. The company can mitigate this risk by hiring an international tax firm to monitor and project tax rates. Those rates can then be loaded into the financial plans. Then, the risk is simply that the company does their job.

Overall, having read the 10-K the biggest risk in this company is management expertise and leadership. Forward looking financial projections built with solid research should alleviate some of the stated risks.

Calculation of Risk vs. Competitors

Within the risk category, Blue Nile comments that the company has more exposure to the overall economic climate that a traditional company or retailer. They base this premise on the fact that their brand focuses on high end or luxury jewelry that has many substitutes which become more attractive during hard economic times (Blue Nile Inc., 2012). This allows a comparison of the risk profile for Blue Nile versus other high end and lower end jewelry retailers.

The beta for Blue Nile (NILE) is 1.18, the beta for Tiffany & Company (TIF) is 1.74, and the beta for Macy’s (M) which carries lower end jewelry is .83 (http://www.finance.yahoo.com). Since, Blue Nile also features the stability of their stock price as a risk we can analyze their risk versus the competition if a downturn in the economy happens. For risk comparison purposes let’s assume that the economy sustains a 10% economic downturn.   The resulting risk would be:

NILE = 1.18 X 10% = 11.8%

TIF = 1.74 X 10% = 17.4%

M = .83 X 10% = 8.3%

Therefore, on a risk adjusted basis a 10% downturn in the economy would negatively impact the stock price of their major competitor Tiffany & Company by 5.6% larger loss than Blue Nile. On the other hand the relatively risk free company Macy’s would see a drop of only 3.5% less than Blue Nile. Effectively, economic retraction, while it will have an impact on the stock, the position of the stock will fall less than the headline company Tiffany & Company, and not that much more than the risk free stock of Macy’s. Therefore, relative to stock price, a 10% decline in the economy should not pose a significant threat, or at least any threat greater than the industry as a whole to Blue Nile.

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