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Bram de Haas
Bram de Haas
Articles (390)  | Author's Website |

Charles & Colvard Deeply Undervalued While Turning Around Successfully

Update on company after slumping share price followed by earnings call

September 10, 2019 | About:

Charles & Colvard (NASDAQ:CTHR) sells moissanite gemstones primarily to millennials. I won the GuruFocus Value Idea Contest with this as an entry. However, it has come down some and is now very attractive again.

Charles & Colvard is a debt-free company trading at a market cap of $39 million. The magnitude of changes at the company are not accurately reflected in its Tuesday stock price of $1.33, which is 44% lower than its all-time peak in May.

Charles & Colvard last quarter made about 10 cents per share per year. That puts it at a price-earnings ratio of 13. In terms of forward earnings, it trades closer to 7 to 9. This is very cheap given that it is generating high earnings growth and has a solid balance sheet.

The company reported earnings and held its earnings call on Thursday. It is making solid progress (it is coming out of a seasonally slow quarter, though) but traded up only slightly. I think this is an underreaction, and the company is deeply undervalued.

Here is a rundown of its progress as discussed in the earnings call and presentation.

Income is at a run-rate of 10 cents per share, and this could could be 20 cents over the next 12 months (forward price-earnings ratio of 7).

It had 19% quarter-over-quarter growth in sales. I suspectthe company is holding back its marketing budget to go big leading up to the holidays at the end of year and Valentine's Day in early 2020. This is most clearly reflected in online sales that only grew 9%, which is slow compared to growth rates over the last few quarters sequentially.

The traditional segment did great with 30% growth, but I think "traditional segment" is now a misnomer. Historically, Charles & Colvard (before its turnaround, development of the "Forever One" quality stone and entrance of CEO Suzanne Miglucci) has been pushing loose stones of lower quality through distributors. Now, it is selling finished jewelry in special cases through Helzberg, a Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B)-owned jewelry chain.

I no longer view this as the "traditional channel." Sure, it is brick-and-mortar focused, but this segment is now clearly representing the new Charles & Colvard strategy, instead of merely liquidating sub-par legacy inventory.

Note that finished jewelry is showing strong growth. That's great because it is higher margin:

Over the year, progress is more clear. In general, online has been growing much faster:

On a more negative note, I was annoyed that the company raised money through an equity issuance last quarter. It raised about $10 million when the stock skyrocketed to $2 per share, and it hasn't spent the money yet. The funds were meant to drive marketing. The company has figured out that it has to spend about $220 to acquire a new customer. That customer spends about $1,000. This spend is coming at the highest-margin channel, the company's own website.

One important thing to note is that online marketing strategies are not very risky. A company can dial back ad spend in real time. This means that if costs of acquisition skyrocket, a company can immediately spend less to try other approaches. The company can't be sure about repeat customer percentages (in the short term), but as long as it achieves positive return on investment on its direct investments, that's gravy. In general, acquisition costs start to rise as it spends more. The company has already plucked the low hanging fruit. It will be interesting to see how hard Miglucci is going to push for new customers and how fast average ad spend will rise (this influences the future growth rate).

The balance sheet is strong with $13 million of cash and $33 million in inventory, but this is now predominantly up-to-date inventory (it used to have lower-quality items included). That it is growing inventory is actually a good sign because it is ramping up for the holidays. Building inventory, in this case, signals expectancy of further sales growth. It also still has no debt and few liabilities.

Bottom line

The bottom line is this is a no-debt company that is on the cusp of throwing significant money into its online marketing efforts as we are moving into the holiday season. Sales should set new peaks in the fourth quarter of 2019 and first quarter of 2020. Meanwhile, the share price is undemanding given current earnings as well as the solid balance sheet.

Disclosure: Author is long Charles & Colvard.

Read more here: 

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About the author:

Bram de Haas
Bram de Haas is managing editor of The Special Situations Report and Founder of Starshot Capital B.V.

Visit Bram de Haas's Website


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