Thursday, August 4 2022

Galeanu Mihai

Introduction

I like to write about underhedged stocks on SA, and today I’m taking a look at Envela Corporation (NYSE: ELA). It’s a re-commerce retailer that has more than tripled its sales since 2016 and looks set to book net income of over $10 million for 2022. The company has a market capitalization of nearly $200 million at the time of writing, but I think that’s cheap given the success of its turnaround thanks to adventure in electronics. Let’s review.

Presentation of the activity and finances

Envela was founded in 1965 and is among the largest authenticated re-commerce retailers of luxury durable assets in the United States. The Company’s business is divided into two operating segments. Its subsidiary DGSE is involved in the purchase, resale or recycling of jewelry, diamonds, precious stones, fine watches, rare coins, gold and silver and it has a network of 7 jewelry stores across the state of Texas and from South Carolina. Its brands include Dallas Gold & Silver Exchange, Charleston Gold & Diamond Exchange and Bullion Express. Envela’s ECHG subsidiary, meanwhile, specializes in the purchase and recycling or refurbishment of consumer electronics and computer equipment. This segment generates revenue through the resale, recycling of end-of-life electronic devices and IT asset disposal services. ECHG aims to extend the useful life of electronics through re-commerce where possible, and recycles products by removing usable components for resale as components or mining the precious metals.

Envela Company Profile

Envelope

Looking at Envela’s latest available financial statements, we can see that the vast majority of the company’s revenue comes from resale and not recycling and that ECHG has much better margins than DGSE.

Envela Q1 2022 Sales and Gross Margin by Segment

Envelope

You can also notice that revenues from both segments recorded significant growth in the first quarter of 2022. DGSE launched an online advertising and marketing campaign during the period and increased its advertising budget by 56%. The marketing campaign appears to have been effective. I think ECHG’s revenue increase, in turn, can be attributed to the purchase of two companies in 2021. In June 2021, Envela purchased electronics take-back and recycling service provider CExchange. In October, the company acquired IT asset disposal service provider Avail. Overall, I think the first quarter of 2022 was a pretty solid period from a financial standpoint for Envela, as gross profit climbed 54% to $9.7 million while net profit rose nearly 32% to $2.7 million. In my opinion, the company should register a net profit of more than 10 million dollars for 2022.

Envela Q1 2022 income statement

Envelope

Turning our attention to the balance sheet, we can see that Envela has a somewhat asset-light business, with cash and inventory accounting for almost half of the asset base in March 2022. Debt stood at 16 $.8 million at the end of the quarter, which I think is easily manageable given that cash and cash equivalents were $11.5 million. In addition, capital expenditures are expected to be approximately $1 million over the next 12 months. In my opinion, Envela has enough cash to fund one or two more acquisitions in the near future.

Envela Q1 2022 balance sheet

Envelope

Envela appears overvalued at first glance, as it has a market valuation of $197.1 million at the time of writing. The company trades at an EV/EBITDA multiple of 17.8x on a TTM basis. However, I think it’s cheap because its business has grown rapidly since the appointment of John Loftus as CEO and President in December 2016. Envela closed 2016 with sales of $48.3 million, compared to $127.9 million in 2012. Net loss, in turn, had increased from $1.6 million to $4 million. So how did the company manage to reconnect with black and surpass its 2012 sales level in less than 5 years? Well, it all started with cutting SG&A expenses. And in 2019, Envela bought Echo Environmental and ITAD USA for $6.9 million from Loftus to create ECHG. You see, Envela’s gross margin was 17.2% in 2016, but the business was barely viable because SG&A expenses were over $10 million a year. I think DGSE is still not a good business due to relatively low margins, and it seems that most of the significant improvement in profitability over the past three years has come from the consumer electronics segment and computer equipment. I think this growth should continue as it has strong momentum that even the COVID-19 pandemic couldn’t stop it. The company has also made several add-on acquisitions over the past few years, and CExchange and Avail are the latest.

As for the risks for the bullish case, I think the main one is the inventory supply. While Envela’s inventory was at a healthy $14.6 million in March 2022, most of that amount was tied to DGSE. The high-margin ECHG business had inventory of just $2.3 million at the end of the first quarter of 2022.

Envela inventories

Envelope

One of the primary sources of inventory for ECHG is school districts, and it’s possible that a recession in the United States will lead to lower education spending, which in turn would hurt this business.

Another risk to take into account here is that the financial results of the recycling activity of the ECHG and the DGSE are significantly affected by the prices of precious metals and other non-ferrous metals. If gold and silver prices fall, Envela’s margins will fall.

Takeaway for investors

Envela has achieved a significant turnaround in its business over the past few years, and I think the most important factor in that has been the purchase and expansion of the high-margin consumer electronics business and ECHG computer equipment. This segment is growing rapidly and its margins remain above 40%, which is why I consider Envela to be undervalued at the moment. If growth rates hold, I think the company’s stock should be trading at something like $9.00 in the near future.

However, I fear that ECHG stocks may be at a low level in March, which could lead to problems in the future. Given this, I consider Envela a speculative buy.

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