2023-09-25 21:09:40 ET
Summary
- Envela Corporation specializes in reselling and recycling pre-owned jewelry and electronics and has a strong management team and growing customer base.
- The pre-owned jewelry market is expected to grow, driven by environmentally conscious consumers, but Envela faces competition from luxury brands.
- The electronic re-commerce market is also growing, and Envela can increase its market penetration through acquisitions and partnerships but faces competition and margin pressure.
Introduction
Envela Corporation ( ELA ) is a re-commerce company specializing in reselling and recycling pre-owned jewelry and electronics. Despite the challenges faced by Envela, the company has a strong management team, a broad product and service offering, and a growing customer base. Additionally, Envela is well-positioned to benefit from the growing trend of sustainability and the increasing popularity of refurbished products. However, I believe the stock needs to get a little cheaper to be a 'Buy'.
Before reading this article, I highly recommend you have a look at these two articles that explain a business overview of Envela:
1. Envela's Venture Into The Electronics Re-Commerce Business Is Paying Off
2. Envela Corporation: Successful Turnaround
Pre-owned Jewelry Market
According to Statista , the second-hand luxury market is expected to grow at 19.61% annually until 2027 (from $444 million in 2021 to %1.3 billion), driven by a more ESG-conscious consumer who is worried about environmental and social damage made by mining and the boom in jewelry as an alternative investment . However, the Boston Consulting Group ((BCG)) estimates the market is expected to grow 8% annually until 2025, far from Statista's expected growth. Furthermore, according to BCG, seventy percent of consumers prefer to buy secondhand luxury products from brand retailers, and seventy-four percent want brands to certify retailers. Thus, if luxury companies start to sell secondary products, they may compete in favorable conditions relative to Envela. However, I think Envela could sell the inventories to them instead of trying to sell them themselves through its retail stores or look for a certification from different brands, giving them a competitive edge against competitors.
The competition is challenging in the infant industry. Many are large marketplaces, such as RealReal ( REAL ), while others focus more on brick-and-mortar locations, and others are mining companies. I believe Envela competes in a market that approximates a perfect competition market, and that’s the reason why margins are so thin in this business unit (35% gross margin on resold units and 5% gross margin on recycled components).
Consumer Electronic Re-Commerce Market
The electronic re-commerce market is another infant industry with many competitors, some of which are focused uniquely on retail refurbished or used equipment such as mobiles, laptops, photography equipment, etc. These companies are small start-ups. Meanwhile, other companies, such as Sims Limited and Great Lakes Electronics Corporation, the first centers on recycling steels and other minerals in various international markets, and the second focuses on buying and recycling IT equipment and holds operations in a few states in the US. Thus, there are many other competitors in a market with low barriers to entry, which may create margin pressure. Nevertheless, I think Envela can deepen its market penetration thanks to its broad partner network and acquisitions. Moreover, as its scale increases, Envela may increase its bargaining power and be able to spread its fixed costs over a larger number of products, developing economies of scale. Management believes the re-commerce market will be a $50 billion market , in which they only have less than 1%.
Moreover, the electronic recycling market is expected to grow at a CAGR of 14.2% globally until 2032, according to Allied Market Research . Other research websites, such as Statista and Market Research Future , set the annual growth around 13.6%-15.95%. In addition, large white goods will be the largest market inside the electronic recycling industry, and it's a segment of the market that Envela hasn’t entered yet, but that may represent another growth driver in the future.
The industry growth drivers are: first, more consumers are preoccupied with environmental damage, but they hardly want to change their consumer habits significantly; second, the demand for some minerals, such as copper, will increase rapidly, so recycled copper will be necessary to meet demand; third, the governments are worried about managing e-crap, so they may impose further requirements to companies to manage their waste correctly.
John Loftus
It’s impossible to write about Envela without mentioning its extraordinary CEO. John Loftus was named CEO of the company when Envela was considered the second-most likely company to go bankrupt, as its sales were constantly falling and operating margins were negative. One of his first steps was reducing SG&A expenses, turning the company profitable. Among the efforts to minimize SG&A, he changed the board of directors (reducing fees), reduced employee benefits, and decreased legal and advertising expenses.
After achieving profits, Loftus concentrates on growth by acquiring Echo (and subsequently related businesses), bringing higher margins and lower risk as Envela diversifies to other new markets. The impact of the Commercial Segment is significant as it accounted for 47% of the net income, although it only accounted for 28% of revenue in 2022.
In addition, John Loftus has a lot of “skin in the game,” as he owns 71.2% of the total outstanding shares. Thus, in my opinion, even if he is the Chairman, CEO, and the largest shareholder, he is completely aligned with other shareholders, so governance risk is low.
Financial Performance
Since 2017, revenue has grown at a double-digit rate, except for 2018, when it actually fell -12.80% owing to a sharp decline in the gold price. In 2019, with the incorporation of Echo Entities, revenue increased by 51.70%. Since then, the company has grown rapidly and keeps net cash reserves to make new acquisitions.
In an interview on Planet MicroCap (YouTube), John Loftus said that the outstanding revenue growth rate is due to Envela’s ability to offer solutions to its clients for managing their waste and old assets. In fact, some of Envela’s customers are Walmart, Microsoft, and Tesla. I think this can give us an idea of how competitive the company is in the market to have such clients. In addition, we need to remember that Envela is just a regional player in Texas, which gives it a lot of opportunities to expand in other states and regional markets by duplicating its business model. Moreover, John Loftus said they have been having problems finding qualified people in the last two years, which has slowed the growth rate.
Furthermore, in the second quarter of 2023, Commercial Segment revenue has fallen due to difficulties in purchasing inventory to be resold or recycled; meanwhile, Consumer Segment revenue keeps growing over 30%, but not the gross profit of resold jewelry as the company is facing stiff competition in prices.
Consequently, even if the operating margin has grown along with revenue in past years, the profitability is decreasing fast as a more significant proportion of the sales come from the Consumer Segment.
Nevertheless, even if the Commercial Segment is decreasing, its gross margins were 67.3% (Resale) and 52.1% (Recycle) in 1H23 compared to 54.3% and 50.2% in 2H22. So, the company is more profitable in its Commercial Segment, and once it manages to purchase more inventory, I expect the margins to go up again. However, the segment's recovery won’t be soon (or at least not in the next quarter) as inventories for resale remained low at the end of the first half, only $624 thousand compared to $1,858 thousand in 2Q22.
Risks
Competition
The re-commerce industry is in its early stages of development, so many small competitors are trying to capitalize on its growth. I think Envela could achieve economies of scale faster than other competitors if it keeps growing at current rates and continues acquiring competitors so that it has access to larger markets. Nevertheless, the risks in such new industries are high, and other competitors may outperform Envela, taking customers and key partners from it.
Commodity Price Volatility
The gross margin on recycled luxury components is 5%, leaving little room for error and making the company vulnerable to sudden falls in gold, silver, or any other precious mineral. In addition, sudden falls in the value of minerals may prejudice Commercial Segment (recycle minerals) and jewelry resold.
Partnerships
Envela’s business success depends heavily on its relationships and contracts with major clients. Thus, these clients have high bargaining power to ask for better prices or services, and if Envela does not comply with those conditions, another competitor may steal the client from Envela. In this sense, specific components are provided by a limited number of suppliers, which are not limited by contract to stick with Envela.
Economic Conditions
In order to buy preowned products, customers must be willing to sell them and buy new ones, which is notably harder when economic conditions are unfavorable, as companies prefer deferred capital expenditures, and consumers begin saving more before the economic uncertainty. Thus, fewer consumers are willing to buy luxury products or electronic devices, slowing the demand and the generation of e-scrap. Nonetheless, I think even if Envela’s Commercial Segment depends on the companies’ capital expenditures, the cyclicality is not so high because IT replacements aim to improve business efficiency rather than increase capacity (which is more susceptible to business cycles).
Governance Risk
John Loftus has demonstrated to be an extraordinary CEO; however, as he accumulates all the power to make any decision, there is a risk that if one of his strategies becomes erratic, shareholders won’t be able to appoint a new CEO. Nevertheless, as I said before, I see the likelihood of this event as extremely low as it has “skin in the game.”
Valuation
For my DCF analysis, I expect the Commercial Segment revenue to grow at a CAGR of 27% until 2028. The Consumer Segment will grow by 30% (2024), 25% (2025 and 2026), 23% (2027), and 18% (2028). I believe these numbers are large but plausible and reasonable for a company with such rapid growth and high returns. Even if John Loftus said in the interview he pretends to grow revenue faster than in the last two years, I prefer to be a little more conservative.
I think the Consumer Segment will grow faster than the Commercial Segment at the beginning due to the focus on opening new retail locations and acquiring Steven Kretchmer (a jewelry manufacturer). Consequently, margins will be lower as the least profitable segment regains weight in the total sales. My discount rate will be 17.75% because the risks are high in a highly competitive industry with low entry barriers.
Conclusion
Envela Corporation is a ‘Hold’ at $5.01 based on an optimistic revenue growth perspective that I firmly believe the company can achieve, given its outstanding financial performance and tailwinds in the re-commerce industry. However, investors should be careful about the degree of uncertainty as this is an infant industry with too many players, low barriers to entry, and bargaining power from customers and suppliers. Lastly, I consider an excellent price to purchase the company will be around $4.35 as the margin of safety will be greater than 30%, given enough protection against awful results in the future.
For further details see:
Envela Corporation: A 'Hold' With Potential