CTHR - Charles & Colvard: What Starting My Own Moissanite Jewelry Business Taught Me

Summary

• Charles & Colvard specializes in the production and sale of moissanite jewelry. Now, so do I. This has given me interesting insight into the company.
• By my research, Charles & Colvard charges much more for moissanite jewelry than many other destinations, putting them at a price disadvantage.
• They have serious inventory buildup issues, sitting on millions of dollars worth of stuff with millions more on the way under contractual raw material purchase agreements.
• I would advise against buying Charles & Colvard in spite of what looks like a low valuation.

My stock screener led me to a new company a few months ago, a jewelry maker called Charles & Colvard ( CTHR ). In an article published here on Seeking Alpha I deemed them worthy of investment due to a niche advantage, that of selling jewelry using a relatively unknown gem called moissanite, and due to a low valuation. More importantly, my discovery of this company got me very interested in moissanite itself. My intent with this article is to share my journey of starting my own moissanite jewelry business and how that has provided me with significant insights into whether or not I think CTHR stock is still a good investment.

Moissanite

So what is moissanite? First discovered in the crater of a meteorite in 1893 by Henry Moissan (from which "moissan"-ite gets its name), who initially mistook it for diamond, it has since been determined how to synthesize gem quality moissanite in a lab. Were it not so, moissanite could never be used in jewelry since naturally occurring moissanite is ridiculously rare and the stones that have been found are too small to serve as a center stone in a ring or the like. It's chemical composition is silicon carbide, with a structure and conductive properties very similar to a diamond. In fact, it is the only stone that can pass as a diamond using a thermal diamond tester.

Under the Moh's scale, which grades gemstones according to their hardness or resistance to scratching, moissanite is 2nd only to diamond, rating above ruby, emerald, the rest of the sapphire family, and cubic zirconia, a popular diamond alternative.

In terms of refraction, or the extent to which light passing through a substance is bent and re-directed back to the eye, moissanite rates higher than diamond, meaning it sparkles more.

As it relates to dispersion, or the extent to which white light entering into the gemstone is broken into the color spectrum, moissanite is also higher on that index than diamond, giving it more "fire", as is the parlance in the industry.

Because of these high refraction and dispersion scores, moissanite is beginning to be referred to as the world's most brilliant gem. Yet in spite of all these advantages in terms of durability and brilliance, moissanite costs 1/10th the price of diamond. Often even less. In my opinion, this makes moissanite superior to diamond. Yet, it is still not well known or very common to the jewelry layman.

Moissanite Production and Evolution

The pioneers in the process of lab-grown moissanite were Charles & Colvard in conjunction with Cree Research in the 1990's. Cree would grow the rough stone and Charles and Colvard would cut, grade, and market it. This process was patented and therefore Charles & Colvard was the only player in the game for a long time. Their first signature moissanite line was called "Forever Classic". This stone carried a color profile of J-K, according to the diamond color scale , which had a slight yellow hue to it. Later, in 2013, they had refined their processing such to produce a near colorless variety of moissanite they called "Forever Brilliant", which landed in the G-H-I range on the diamond color scale. Then in 2015 they launched "Forever One", the first truly colorless moissanite, or D-E-F on the diamond color scale. For several years the "Forever One" was the best moissanite money could buy. However, in 2018 the patents associated with the Charles & Colvard production of moissanite expired. Many competitors entered the scene, and technology has allowed them to produce moissanite every bit as good, in my opinion, as "Forever One". While there is still a lot of prestige attached to the "Forever One" name, and you will most definitely pay a premium for the brand, there are plenty of excellent options on the market.

To illustrate the above points, allow me to share a personal experience I had a few months back. I was talking about moissanite with someone who has been in the diamond trade for decades. I pulled out a small box which contained three stones, all of them identical in terms of graded color, clarity, cut, shape, and carat (colorless, VVS1 clarity, excellent cut, round half carat). Two were moissanite and one was a lab-grown diamond. I asked him to identify what he saw. He pulled out his jeweler's loop, a simple magnifying glass at 10X magnification, and inspected each. He correctly identified the lab-grown diamond, a stone that had cost me $500. He correctly labeled another as moissanite. The final stone he thought was a NATURAL diamond. Here is the fascinating part: the moissanite he correctly identified was a Charles & Colvard "Forever One" and cost me ~$250. The stone he thought was a natural diamond was a generic, off-brand moissanite that cost me $50. An actual natural diamond of that size and quality would have easily cost $1,500.

Pricing Practices

I feel that the reason CTHR may have trouble with their moissanite business going forward is pricing. It is easier than ever to comparison shop nowadays, and people are always searching for a bargain. Why pay up when you could have a substantially similar item for less money?

In my opinion, CTHR is trying to sell their moissanite jewelry for WAY too much money, such that they are pricing themselves out of consideration. A big part of the reason people explore moissanite is to save money. But CTHR moissanite prices approach that of diamond. Here are two products from the Charles & Colvard website, both stones being of identical size, color, clarity, and cut:

The settings are in 14K gold and of comparable style and size. The one pictured first is a moissanite ring that costs ~$1,300. The second has a lab-grown diamond and it costs ~$1,800.

Now, if you peruse any website talking about cost comparisons between diamond and moissanite you will find that moissanite should cost 1/5th or so the price of a lab-grown diamond. Yet in our example, the discount is only 25%! And here is where the rubber really meets the road. Check out this ring from my website, same size, color, cut, and clarity of stone as the above examples, also set in 14K gold:

I sold this for $300. And I collected a respectable profit.

To exaggerate yet further, check out this solitaire from my friends over at Gigajewe. It costs $520.

The ring shown here is with a TWO carat stone and the gold is 18K instead of 14K. Bigger rock AND higher gold content, yet still almost 1/3rd the price of the Charles & Colvard moissanite shown above.

I could go on with more examples, but I think you get the point. CTHR is no longer the only player in the moissanite game. They have plenty of competition, and many of them are undercutting them on price in big ways.

Perhaps due to this, CTHR launched a more budget friendly website called "Moissanite Outlet" where they offer reduced prices on inventory they couldn't move on their flagship website. Prices are more palatable here, but still well over what others are selling for. Here is an item that looks similar to the one from my website:

It's a one carat in 14K gold, but the stone is of lesser quality, being "near-colorless" rather than colorless. The price tag on this is $818. More expensive than competitors for an inferior stone.

I see one of two things happening, neither of them being good for CTHR. Either they will have to reduce prices substantially to stay competitive, slashing profitability, or they will be passed over entirely. With as easy as it is to shop around now-a-days, and without the name brand power of behemoths such as Kay Jeweler's or Jared, Charles & Colvard may not be able to become the destination of choice for moissanite jewelry.

Lab-grown Diamonds

Interestingly, Charles & Colvard launched a line of lab grown diamonds in 2020 called Caydia. My opinion is mixed in regard to this. On the one hand, I can personally vouch for the fact that there are A LOT of diamond purists out there. If it isn't diamond, it isn't worth it. That being said, the vast majority of diamond purists I have talked to insist on NATURAL diamonds. In any case, the justification for this launch was to widen the customer base and to underscore the moissanite value proposition by allowing customers to see pricing of each side by side. The CEO was quick to point out positive indicators for the Caydia line shortly after launch:

One of the other things that it’s done for us that we’re seeing immediately... is it’s driving more traffic. It’s driving more awareness to our brand. It’s driving more awareness to us being the destination, putting us in the conversation, where that consumer now comes to us, they learn a little bit more, and they’ve never really kind of experienced Forever One moissanite in the past and now they are getting more educated. They are able to see the price comparison between the lab grown diamond as opposed to our Forever One moissanite, and they are gravitating also into lifting our moissanite as well. And what we’re seeing early on indication in Q1 was that it actually is lifting our AOV (average order value) on the moissanite side. We anticipate that we’ll maintain strong AOVs, and we will get a slight lift to that a little bit as well.

The average order value is a metric worth discussing further. It is simply a measure of how much each customer spends when they buy from CTHR. Historically their AOV has been $1,000. Their claim was that the introduction of lab-grown diamonds was lifting that number. After a full year of their Caydia offering, AOV is up slightly to $1,100.

Now, this metric has considerable limitations. AOV can go down and the business still be absolutely thriving, for example if suddenly there was a rush for say, stud earrings, which cost way less than a ring. But it does help us understand their claim of the lab-grown diamonds pulling up AOV.

It is too early to mark Caydia as a success or not. Ever since launch they have only reported by how much lab-grown diamond sales have grown on a percentage basis over comparable periods. We don't have any dollar amount to go off of. This lack of transparency and specificity works against them and is a mark against them.

Other Key Metrics

Their other claim is that Caydia is helping them drive brand awareness and get new customers. Raw revenue numbers are the best indicator of that, and here has been the trend:

Indeed, revenue saw an impressive surge starting in the latter end of 2020. Was this due to lab-grown diamonds? Perhaps in part, but we don't have enough data to parse that out for certain, especially since CTHR has aggressively increased their advertising budget recently, which I would wager has done more to help them drive sales than introducing a diamond offering, though those things aren't mutually exclusive. Here has been their ad spend going back through 2014:

While they don't break out strict return on ad spend numbers (ROAS, or the revenue attributed to ads), we can proxy that lightly by dividing total revenue by ad spend. Here are those ratios, with bigger numbers being better:

*Transition period, Jan-Jun

As can be obviously seen, pumping their advertising budget isn't having the multiplicative effect one would hope. It would seem that every incremental dollar they spend on advertising results in LESS incremental revenue. Yes revenue is going up, but it is costing them an awful lot to chase those dollars. This could be indicative of advertising campaigns whose content and/or the medium used aren't effective.

For a couple years CTHR actually broke down how much money it cost them to acquire a new customer "based on the total advertising spend focused on charlesandcolvard.com traffic divided by the number of first-time customer orders." That number was $220 in 2019 and $275 in 2020. I wish they had continued to report that data, but the two years they gave us wasn't promising.

For the same two years they also shared what percent of their total orders were from repeat customers. It was 28% in 2019 and 17% in 2020. While two numbers don't make a trend, it still isn't good.

My concern with all these data points is that taken together, there is great cause for concern. Yes revenue is going up but it is costing them ever more money to get that greater revenue.

Inventory

CTHR has a ton of inventory. The way they are currently valuing it, there is $1.15 worth of inventory PER SHARE. With CTHR currently trading at ~$0.90, the value of their inventory alone is 25% higher than the share price! The problem is that their inventory isn't moving, and it hasn't been for a while, which calls into question whether or not that inventory is actually worth the amount the company claims. Check out this breakdown by year of how inventory levels have changed at each level of the production cycle:

These numbers are the reverse of what a healthy inventory position should look like. Ideally, a company would have a smaller finished goods inventory backed up by a larger in-process and raw materials supply. Such would typically indicate that the product is in high demand and the company can't keep stuff on the shelves for all the buying and they are working on building up supply to meet demand. Not so at CTHR. Their finished goods inventory is a multiple of both raw material and works-in-process combined. And their inventory number balloons every year. People don't want what CTHR is trying to sell, at least not at the volumes that they have on hand.

The genesis of this issue is a contract that CTHR made with a company called Wolfspeed, formerly Cree Research already mentioned, that requires CTHR to buy so much moissanite raw material from Wolfspeed every single quarter. That agreement was initially entered into in 2014 and was set to expire in 2018 and called for a total purchase commitment of $53 million. The contract has since been extended, twice, through June of 2025, with $26.55 million still remaining to be purchased. With nine more quarters to go, they must spend nearly $3 million every quarter until then. If the CTHR line of products doesn't take off soon, expect more inventory issues moving forward.

This issue has become significant enough to be marked as a "critical audit matter" by the company's auditor in the most recent 10-K and in last years. In particular, the auditor had to work hard to try and....

..... determine whether management identified evidence of potential declines in marketability, including slow moving inventory, for which carrying value may exceed estimates of net realizable value and appropriately evaluated potential reserves.

Certain of the Company’s inventories are subject to various market factors, including changes in styling trends, that could indicate a decline in the net realizable value. Given the inherent uncertainty in estimating the future marketability of the Company’s products, auditing management’s estimation of the net realizable value of inventories required a high degree of auditor judgment and increased audit effort.

The good news is that this last quarter showed inventory actually decreasing by $1.6 million. Furthermore, last year was the first year where finished jewelry inventory finally surpassed loose gem inventory in dollar value. This shows that they are delivering on their goal to focus on primarily offering finished jewelry, whereas for many years prior they were more of a loose gem wholesaler. This means also that much of the dollar value associated with the finished jewelry inventory is comprised of precious metal in addition to moissanite, which metal is much easier and more reliable to valuate as it trades daily on public markets. So those are a couple positive signs.

All told, inventory has long been and will continue to be a big matter of concern. However, they may be turning the corner. Subsequent quarterly reports will let us know if they continue on this healthier trajectory.

Conclusion

I would not consider CTHR investable at this point in time. This is an admitted flip-flop, as I published a bullish article on CTHR in May of 2022. However, between then and now I started my own business selling moissanite jewelry. Such an expedition has taught me a lot.

As it relates directly to CTHR, I have learned that the company is overpricing their product such that they may be pricing themselves out of consideration. Then there is the big issue of inventory. They have tons of it, and the fact that it isn't selling calls into question whether or not they are valuing it accurately. They are also spending a lot of money on advertising and brand building, but those efforts aren't bearing fruit in any efficient way. In my opinion, shareholder value can be unlocked best through a sale of the company to a large, big-name brand.

Those three reasons are my primary reasons to recommend avoiding CTHR at this time, notwithstanding what may look like a tempting valuation.

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