Charles & Colvard (CTHR)
Finally ready to sparkle?
Charles & Colvard (CTHR - $63.6M) is a fine jewelry company that sells moissanite and lab grown diamonds. They were the first company to produce and patent moissanite gemstones back in 1995. The company markets its moissanite diamonds under the Forever One brand and its lab grown diamonds under the Caydia brand.
Charles & Colvard portrays its diamonds as unrivaled by any other jewel and above the quality of competing brands. The company has multiple sales channels and a customer base that is skewed towards younger generations.
A diversified business model covers multiple distribution channels including drop-shippers, marketplaces like Amazon, retail stores like Macy’s and its own direct to consumer platform. With an enterprise value of only $63.6 million, this is a tiny micro cap stock that is thinly traded and has a mixed past.
Source: Company presentation.
The Advantages Of Lab Grown Diamonds
Moissanite and lab grown diamonds are seen as an ethical and affordable alternative to mined diamonds. The majority of mined diamonds take a high toll on the environment and human life. The image of natural diamonds has been forever tarnished by the movie Blood Diamond which brought home the realities of diamond mining in many parts of the world.
Although Charles & Colvard counts customers across the generations, moissanite and lab grown diamonds are increasingly popular among cost conscious and environmentally conscious millennials. As reported in a recent investor summit, 45% of web traffic to charlesandcolvard.com comes from Millennials while 26% comes from boomers.
Source: Company presentation.
Given the choice, many millennials would rather save money with a lab grown diamond and put that cash towards a house than buy an expensive natural diamond that has questionable ethics.
Earlier this year, investors picked up on a trend across social media platforms like TikTok. Social media users have been posting videos about the negatives of natural diamonds versus the advantages of moissanite and lab grown diamonds.
This trend no doubt contributed to Charles & Colvard’s strong earnings in the previous two quarters and has propelled the stock to a 270% price gain in 12 months. Net sales were up 45% in Q3 compared to a year prior.
This trend is still in place as shown by the Google trends data below which highlights the search terms ‘moissanite ring’ and ‘lab grown diamond’:
Source: Google Trends.
Furthermore, web traffic data for charlesandcolvard.com is strong and moving higher. According to web analytics firm SEMRush, the Charles & Colvard website received over 400K visits in June.
Organic traffic has also been moving steadily higher as shown by the graphic below. These are good signals as the company has made e-commerce a priority.
One negative aspect is that the Google trend for the search term ‘Charles & Colvard’ is not nearly as strong as that for moissanite or lab grown diamonds. The company has a bit to do in terms of brand recognition:
Source: Google Trends.
A browse of Reddit indicates that moissanite and lab grown diamonds have a reasonable size following. Comments are generally positive towards moissanite for all the reasons stated previously. Charles & Colvard (despite a handful of negative reviews) is also regarded as a higher quality vendor.
However, there are also numerous posts regarding Chinese made moissanite as well as rings bought from online marketplaces like Etsy. Despite most preconceptions, Chinese moissanite from outlets such as Stargemz and Mona generally has good reviews and is more affordable than Charles & Colvard.
There also seems to be some gamesmanship whereby users attempt to seek out the best moissanite for the lowest cost. The concern, with so many moissanite producers, is that we see a race to the bottom and margins get squeezed. The following Reddit link shows a long list of outlets that provide moissanite jewelry.
Total Addressable Market (TAM)
According to industry reports, the future of lab grown diamonds is robust and set to grow steadily over the coming years. Jeweller magazine estimates that the lab grown diamond market is worth $5.2 billion today and set to grow to $15 billion by 2035. This means lab grown diamonds occupy the fastest growing segment in the fine jewelry space.
Meanwhile, Banyan Hill puts the worldwide market value of lab grown diamonds at over $22 billion and set to grow to $29 billion by 2025.
Elsewhere, a report by IGDA puts the market share of lab grown diamonds at 10% by 2030. With a market cap of only $80 million, Charles & Colvard only needs to capture a slither of this market in order to grab sales and advance its value.
Moissanite Versus Lab Grown Diamonds
It’s important to note that these charts only cover lab grown diamonds. Moissanite (which Charles & Colvard are a leader in) is a separate product that is slightly softer, more refractive and cheaper than lab grown diamond. Charles & Colvard’s Caydia diamond is relatively new and only launched at the end of Q3.
Certainly, in the lab-grown diamond, we believe that the market opportunity is tremendous, probably more so than the moissanite. But for right now, what we're seeing is the moissanite business is growing at a higher level and a higher pace than the diamond business.
CEO, Dan O’ Connell on recent earnings call.
In terms of customer uptake, surveys reveal that consumers are becoming more aware and complimentary towards lab grown diamonds. MVI report that 66% of consumers would consider a lab grown diamond for an engagement ring and 23% would definitely buy one.
Retailers have also been supportive of the movement towards lab grown diamonds. According to IGDA, once retailers are able to share the story behind lab grown diamonds, the sales conversion rate goes up to 60%. Furthermore, a recent study of 800 + retailers placed lab grown diamonds as their number one breakout category in jewelry.
Charles & Colvard is the original creator of synthetic, gem quality moissanite which it first patented back in 1995. However, this patent expired in 2015 allowing new entrants into the market.
Today, there are synthetic diamond manufacturers all over the world with a large portion coming from China. Charles & Colvard contends that its gemstones are a cut above the rest. They are backed by warranty and truly sustainable with the use of recycled platinum and gold in the rings themselves.
Charles & Colvard has some patents, is developing a good brand and has a strong network of revenue streams which contribute to an efficient business model.
However, Charles & Colvard does not have any significant competitive advantages that I can see. There are also a number of big competitors entering the market. This is mostly in the lab grown diamond space, not moissanite, however. For example:
De Beers, a leading diamond company, reduced diamond production by 15% in 2019 and is now investing large amounts of capital into lab grown diamonds under it's Lightbox brand.
Diamond Foundry is a pure play manufacturer recently valued at $1.8 billion. This private company is backed by celebrities such as Leonardo Di Caprio. Diamond Foundry also is also involved in industrial use diamonds. Lab grown diamonds can be used in numerous industrial applications such as in mobile phones and electric vehicles. (This would be a compelling market for Charles & Colvard to enter into though they show no sign of doing so).
Pandora, the world’s biggest jeweler said it will switch exclusively to lab made diamonds. They said that there is a clear demand for both types of product, natural and lab grown.
Although there is competition risk, the entrance of bigger players into the market also validates the business opportunity and drives more consumer awareness of lab grown diamonds. This is beneficial to Charles & Colvard and also makes the company a potential acquisition target.
Charles & Colvard is currently headed by CEO Don O’ Connell who took over from Suzanne Miglucci in May 2020. O’Connell has over 25 years experience in the jewelry industry and previously worked at the Richline Group, a subsidiary of Berkshire Hathaway.
Since taking over, O’Connell has taken steps to navigate the company through COVID and reposition it for ecommerce. He has reduced staff by 25%, renegotiated supply agreements and seen sales increase in the nine months since his appointment.
Source: Company presentation.
As shown in the graphic below, operating expenses are sharply down on the year prior even though sales (as shown above) are broadly up.
Source: Company presentation.
Another important consideration with this stock is that it has seen considerable insider buying throughout the last 12 months.
Charles & Colvard currently trades at a market cap of $77.9 million. With a cash pile of $19.6 million and debt of $5.3 million, the enterprise value comes to $63.6 million.
Cash has increased from $14.6 million in 2020 to $19.6 million in 2021 representing an increase of 35%. Meanwhile, debt is almost entirely in the form of a $1 million PPP loan which may be forgiven. There is also a $5 million credit line.
With sales of $33.9 million and EBITDA of $4.3 million that means the company is currently trading around 1.9 times sales and 15 times EBITDA. These are not expensive multiples but they are not outrageously cheap either.
Although revenues have shown impressive growth in the last two quarters, the longer term picture is mixed and the average 10-year sales growth is only 7.8%. As can be seen from the chart below, revenues have not yet regained their 2005 peak:
Earnings have also been volatile with the company reporting negative EBITDA in 2013, 2014, 2015, 2016 and 2018. Furthermore, in summer of last year, the company was in danger of being delisted from the Nasdaq for a share price under $1.
A key question for investors, therefore, is whether the market for moissanite and lab grown diamonds is finally taking off and we are on the cusp of a profitable wave. Or, is the recent spike in sales more of a cyclical move?
Charles & Colvard has been in operation for 25 years and its business performance has fluctuated considerably over that time. The company remains a micro cap and has all the risks associated with such small companies. Many such risks can be viewed by going to the risk factors section of the annual report.
Is the recent spike in demand for moissanite and lab grown jewelry a temporary effect brought on by social media or is this time truly different?
Final Thoughts - What Is Going On Here?
There are things to like with Charles & Colvard. Industry reports and Google trends data indicate that moissanite and lab-grown diamonds are a growth area and here to stay. I also like the web traffic data that shows the website is receiving plenty of organic traffic.
The small market cap and large cash pile mean it is in a good position to deliver returns to shareholders if products continue to sell. The partnership with Macy’s and other retailers gives the company multiple sources of revenue.
However, Charles & Colvard is a micro cap company with a long history of weak performance. There are considerable risks and no certainty that demand for moissanite or Charles & Colvard products will continue to grow at the pace required.
My suspicion is that the market for moissanite will likely tail off and be overtaken by the market for lab grown diamonds. Therefore it’s good news that Charles & Colvard has launched their own lab grown brand Caydia.
The next few quarters will be key to understanding whether the business is strengthening and if it is even viable long term. Although industry trends look promising, there is not enough evidence of strong profits to make this a high conviction play.
The number of competing outlets is also a cause for concern. My feeling is that the market for lab grown diamonds could eventually dissappoint investors. But Charles & Colvard could put together a decent run until that happens.
Thank you for reading Unexpected Value. This newsletter relies on word of mouth. If you enjoyed this post please subscribe and help spread the word!
Disclosure: I no longer own CTHR and have no plans to buy any more. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst and does not purport to tell or suggest which securities customers should buy or sell for themselves. The reader agrees to assume all risk resulting from the application of any of the information provided. We strive to provide accurate data and analysis, however, mistakes and errors do occur. Financial investing is risky and not for everyone. You should not bet more than you can afford to lose. Past performance is not indicative of future results.