Charles & Colvard: A Turnaround Value Stock Worth Looking At

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About: Charles & Colvard, Ltd. (CTHR)
by: FinanceSwipe
Summary

CHARLES & COLVARD (CTHR) has enacted an excellent turnaround strategy that has seen the firm produce notable profits in the past 3 quarters.

CTHR is taking advantage of eCommerce and international sales to greatly increase their total sales.

We see 72% potential upside in this stock with the firm trading at a more reasonable P/E close to its industry.

Investment Thesis

CHARLES & COLVARD (CTHR) is an attractive investment at current levels due to a rapid increase in revenue, led by improved international sales, a great increase in eCommerce sales and a solid marketing effort by the company.

CTHR is poised to take advantage of long term positive eCommerce trends. The company is rapidly increasing earnings and gross margins. There was net income of $810,000 in Q3 2019, in comparison to close to a ~$600,000 loss in the quarter in the year before. Gross margin was 47% this quarter in comparison to 37% a year ago. This is the result of increased efficiencies in the supply chain.

Company Overview/Background

CTHR was founded in North Carolina in 1995. The firm manufacturers, markets and distributes 'Charles & Colvard Created Moissanite.' Charles & Colvard creates maisonette jewellery in their lab.

The jewellery is sold through two segments:

  • online channels (53%)
  • wholesale, retail and television customers (47%)

The online channels include their own website, e-commerce outlets, marketplaces such as Amazon and eBay and other dropshipping customers. CTHR is the only maker of patented Moissanite worldwide with the market set to grow from $25.5 million in 2014 to $48.83 million by 2025. This represents a CAGR of 6.2%.

Moissanite is up to 90% cheaper than a diamond of the same type of appearance. A 1 carrot diamond costing $4000 would be $400 for a 1 carrot moissanite. This highlights the value that customers get in buying the product. CTHR produces this rare gemstone themselves in a lab, with silicon carbide.

McKinsey & Company by 2020 see the online jewellery market to reach $45 billion in sales (15% of the global jewellery market). Global online fine jewellery is set to reach $30 billion of the overall global jewellery market. The lab-created gemstone opportunity that CTHR produces is expected to reach $8 billion in total market size. The online fine jewellery shopper and emerge of lab-created gemstones represents a great opportunity for CTHR and its customers.

The image above shows the difference between a Diamond ring and Moissanite ring.

Recent Stock Price

CTHR was recently trading at around the $1.2 area before hitting $2.44. This increase was prompted by the recent earnings and bullish statements in the earnings call. These will be covered below. The stock since then has fallen to $1.6, presenting a good entry point, at a level that makes CTHR a deep value play. We address this in the valuation section below; we think that the firm still trades at a discount in comparison to the market.

Mispricing

eCommerce

CTHR has rapidly increased its eCommerce earnings with a 38% increase in net earnings compared to a year ago. 53% of CTHR’s total net sales now come from their eCommerce channels. The major selling channels are covered with eCommerce including their website, third-party online marketplace, dropshipping and other eCommerce outlets. We see this as a very positive sign as eCommerce continues to grow rapidly as a portion of total retail sales. CTHR is aligned well with long term trends and profiting as a result. eCommerce played a huge role in the company earning net income of $810,000 and EPS of 0.04 in Q3 2019 in comparison to a net loss of $0.03 a share a year ago.

We had a look at CTHR’s Amazon page and felt there was still considerable investment that the firm could put towards its Amazon channel. Most of the items that the company sold on Amazon were via ‘Fulfilled by Merchant.’ This means that the items are shipped straight from CTHR to Amazon customers. On Amazon, its ‘Fulfilled by Amazon’ that generates the most amount of sales. That’s because of Amazon’s huge Prime Membership base that benefit from next day delivery when they get a product on ‘Fulfilled by Amazon.’ Also as well Amazon’s search algorithm gives preference to ‘Fulfilled by Amazon’ customers. Although we could argue that this is a positive because it could execute better on Amazon with the possibility of increasing sales from this channel moving forward.

eCommerce overall represents a bright spot for the company. International Sales and Digital marketing through eCommerce will lead to an increase in revenue and net profit for the company moving forward.

International Sales

CTHR has also increased international sales rapidly with 107% growth over the prior year quarter. These increased international sales are through the new cross-trade technology platform that the company has released. The international sales are mainly across Japan and Europe. CTHR has also verified demand from the Japanese market that is doing well. CTHR has therefore started selling on the Amazon Japan marketplace as a result. International sales are solely through the e-Commerce model, which makes scaling really easy. The sales iCTHR has increasingly used digital marketing as a way to target international customers to its US website. We believe that the international market will continue to be a positive for CTHR and will lead to increased revenue for the company. One of the benefits of selling to international markets is that the cost of advertising can be cheaper than countries such as the US and UK. The US tends to have larger per customer costs on marketing channels, in comparison to countries like Japan. We don't think that the market has fully appreciated the opportunity that is available to scale across the world. All that is needed is for CTHR to send some inventory to another country, such as an Amazon Warehouse and for digital marketing in that country. This doesn't cost a lot. This will allow revenue to increase rapidly in the future. In the recent earnings call, international expansion was highlighted as a huge opportunity.

Digital Marketing

CTHR has an excellent digital marketing strategy that is aligned with the best marketing strategies of today. The firm is targeting the most popular marketing channels today including digital marketing, social media marketing and investing in video advertisements for improved ad spend. In the marketing space video advertisements are some of the cheapest advertisements at the moment. CTHR has noticed this and will be investing more money in videos going forward. This should be a positive for earnings going forward. We believe that CTHR has a good grasp of marketing which is ‘leading to good web site traffic and conversion rate resulting in continued growth.’ There are a lot of companies that are doing a really bad job with their marketing strategy, marketing as if it was the year 2000, not the year 2019. This includes a lot of Fortune 500 companies and as popular entrepreneur Gary Vaynerchuk states, 'this is the reason why they have been losing market share.' CTHR on the other hand has a modern digital marketing strategy. The cheap cost of marketing these days on platforms such as Facebook, Instagram and Influencer marketing, allow companies like CTHR to scale at a rapid pace and generate substantial profits. That allows CTHR to look at avenues like video and scale up earnings at a rapid pace. Management have stated that they are looking at investing more in videos.

Valuation

The firm generated net profit of $2,113,553 in the 9 months ended 31st March 2019 with an EPS of $0.10. The company will hopefully be able to grow this going forward. Based on a yearly EPS of $0.14 the company is trading at a P/E of around 14.2. The Luxury Goods sector has an average P/E of 19.89x. CTHR is only in the early stages of a huge turnaround as a company as well. We believe it deserves a multiple of around 20 like the market average. CTHR has historically had a P/E of 36 on average in the past 10 years. We have a price target of $2.8 for the company. We believe that the company will be able to maintain an EPS of $0.14 going forward based on their recent earnings. This represents earnings of around $3 million a year. Applying a multiple of 20x drives a total market cap estimate of around $60 million. That represents around 72.6% appreciation from current levels.

CTHR has a very healthy balance sheet. It has almost no debt on its balance sheet which is incredibly healthy. The firm has $41,230,707 in assets and only $6,372,081 in liabilities. This makes the book value about $35 million. The market cap of the company is only $42.21 million, equating a low P/B of 1.2. We believe this is a healthy P/B ratio in an industry that on average has a P/B of 1.61.

Risks

Moissanite Demand & Concentration

The rings that are sold are moissanite, which only makes up 1% of the jewellery market. They are therefore not widely recognized. CTHR is therefore reliant on the moissanite industry that is not well known as say diamonds. It’s a very particular niche.

There is a very limited customer base for moissanite; only a few distributors, manufacturers and retailers that the company is reliant on. This highlights how supply is not as plentiful for moissanite as it would be for example diamonds. If any of these firms were to go bankrupt, it would have an adverse effect on CTHR’s business. During 2017, the 3 largest customers which were loose jewel and finished jewelry distributors accounted for 38% of net sales. The customers themselves have not been disclosed in CTHR's 10-K report. We could argue that losing one of these customers would be detrimental to CTHR, on the other hand eCommerce is growing at a rapid rate. This is CTHR going direct to consumers itself, so it has less of a reliance on distributors than it used to.

Jewellery Market Competition

The jewellery market as expected is highly competitive. There are low barriers to entry in the industry and this means heavy competition. In the eCommerce market that CTHR competes on there are many other jewellery sellers as well. Although with the internet and the opportunity to advertise to audiences around the world, we could argue there is more than enough space for CTHR to sell its products. In addition to this CTHR focuses in the Moissanite space which is a very particular niche within Jewellery. Focusing on a particular niche allows the company to stand out in comparison to competitors.

Reliance on 3rd party eCommerce Platforms

CTHR is reliant on 3rd parties for a lot of its eCommerce sales, which have a high material impact on sales. These platforms include Amazon, eBay, Jet, Walmart and Gemyara. These 3rd parties could make changes such as Amazon banning the company’s account for product violations. Amazon has never banned CTHR in particular, but it has been known to ban seller accounts in the past for violations, even if they are small mistakes. Sometimes there are Chinese sellers that are known to play against the rules against their competition. A few fake reports of an Amazon account could lead to Amazon doing some enquires. There is an appeal process, though, but it would take CTHR a month to get their account back. This would be bad for earnings. On the other hand we could argue that these 3rd parties need companies like CTHR to sell on their platforms to make them a success. CTHR sells heavily on Amazon and eBay where it has established solid reputations. There is therefore little reason for these 3rd parties to kick the company off their platforms. We see the actual risk of CTHR being banned as low.

Conclusion

We believe that CTHR is in the early stages of an excellent turnaround, that is generating notable profits for the company. There is a clear opportunity for the company to scale up operations and generate revenue from International Sales and their Digital Marketing strategy. This makes CTHR an exciting company to invest in. We believe that the company is worth around $2.8 which represents 72% price appreciation from its current levels. That’s as the firm continues to grow revenue through its eCommerce channels, fantastic digital marketing strategy and increased sales internationally.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.