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As China’s economy continues to grow, so will the wealth of its citizens. As evidenced in the United States and around the world, people moving into the middle class and beyond have an increased desire for jewelry. This is something that continues to grow with their new found status. LJ International, Inc. (NASDAQ:JADE) is well positioned to take advantage of the continued upward mobility of the Chinese.

Brief History and Profile

The company is currently engaged in the designing, branding, marketing and distribution of a full range of jewelry as well as owning a chain of retail jewelry stores in China. The company was founded in 1987 as a gemstone factory in Hong Kong and added a gold factory the following year. LJ continued to expand and in 1998 went public on the NASDAQ. The manufacturing and wholesale jewelry business continued to grow revenues until peaking in 2007. In 2007, the global recession took its toll on wholesale revenues and profits. In 2004, the company started ENZO, a chain of retail jewelry stores in China and in 2005 ENZO became the first foreign jewelry retailer in China. Since that time, ENZO has quickly grown to over 100 stores.

The Business

LJ has two distinct operating segments that operate in the jewelry business. The manufacturing/wholesale distribution segment, which has returned to growth after surviving lower sales during the recession. Then there's the retail segment, which could be the real catalyst for growth.

Wholesale Distribution

The wholesale segment designs, markets, and distributes a full range of jewelry to fine jewelers, department stores, national jewelry chains and specialty retailers including TV shopping channels. This segment distinguishes itself with the use of vibrantly colored gemstones and unique designs. The wholesale segment saw revenues peak in 2007 at $118 million, when the global recession hurt orders.

Most of the revenue for this segment is derived from the United States, followed by Western Europe and Japan. It boasts key customers such as JCPenney (NYSE:JCP), Macy’s (NYSE:M), QVC (LINTA), and Zale’s (NYSE:ZLC). This segment is showing signs of recovery with positive year over year comparisons, giving the company hope that the worst may behind them. Revenues for the quarter ended June 30, 2010 were up 38%, when compared to the same period in 2009. Through the first half of 2010 this segment accounted for just under 50% of total revenue.

ENZO Retail

ENZO was launched in 2005 and experienced very rapid growth over the next three years. The company achieved a store count of 100 by 2008. The growth of new stores slowed for a short time, but has now resumed an aggressive expansion. The company is projecting 200+ stores to be opened by mid-2012. At the end of August 2010, the company had 113 stores.

The retail segment accounted for roughly 50% of the revenue in the second quarter of 2010, but supplied 75% of the operating profit. The company has decided to focus on smaller markets where they believe there is the most potential, while staying away from the largest markets that are already saturated. All of the retail stores are in malls, with the exception of LJ's first standalone store opened in August 2010. Located in Cixi, about 90 miles south of Shanghai, the new standalone store is approximately 1500 square feet and represents a milestone for the company.

The Financials

Income Statement

The financial performance appears to be back on track in a big way. LJ reported that revenues had increased 47% to $33 million. Net income was up substantially from $0.01 in the second quarter of 2009 to $0.09 per share for the second quarter ended June 30, 2010. The company added a net total of 13 new stores in the second quarter which should bode well for the third quarter which just ended. The company was projecting total revenue of $34 million and net income of $3.8-$4 million or approximately $0.15 per share for the third quarter. However, the net income number includes a $1.6 million one-time gain on the sale of investment property. Without this gain, net income for the third quarter is expected to come in at approximately $0.09 per share.

Balance Sheet

As of June 30, 2010, the company had cash and cash equivalents of $5.6 million and long-term debt of only $2 million. Cash balances have fallen through 2010 due to increased investment in inventories for the opening of new ENZO stores, but remain at an acceptable level. In addition, the company’s working capital stood at $79.2 million at the end of the second quarter, giving the company plenty of flexibility.

Conclusion

All signs seem to point up for this small Chinese jewelry company. The wholesale segment appears to be recovering from the global recession, while the retail segment has resumed its aggressive expansion. The stock has bumped up since reporting second quarter results. However, shares still appear to be attractively priced considering the expansion of revenues and earnings. As the retail segment becomes a larger percentage revenues, margins should expand at an increased pace as well. The next three quarters should show seasonality strength as the retail segment will benefit from Christmas and the Chinese New Year. The wholesale segment should pick up in the third quarter in anticipation of the Christmas season.


Disclosure: The author holds a long position in JADE at the time of this writing. No positions are held in any other stock mentioned in this article.

Source: LJ International: Banking on a Jaded Chinese Bourgeoisie