In July 2022, I wrote an upbeat article on SA about re-commerce retailer Envela Corporation (NYSE: ELA) in which I said that the company had achieved a successful turnaround thanks to its adventure in electronics segment and it looked cheap.
Well, revenue fell 10% QoQ in Q2 2022, but the company’s gross margin jumped to 26.9% from 20.5%. That helped Envela post a record quarterly net profit of $3.85 million, but I fear inventories in its electronics arm will be low at the end of June. Given that the market valuation has dropped to $134.1 million at the time of writing, I believe the company is even more undervalued than in July. Let’s review.
Overview of Q2 2022 financial results
In case you haven’t read my previous article on Envela, here is a brief description of the company. The company is one of the largest authenticated re-trade retailers of luxury hard assets in the United States, and specializes in the sale of precious metals and gemstones as well as consumer electronics and computing equipment. . Cash and inventory typically make up about half of Envela’s asset base and the company has two subsidiaries, namely DGSE and ECHG. The former is involved in the purchase and resale or recycling of jewelry, diamonds, gemstones, fine watches, rare coins, gold and silver and owns 7 jewelry stores in Texas and South Carolina . ECHG, in turn, specializes in purchasing and recycling or refurbishing consumer electronics and computer equipment and its primary source of inventory is school districts. Additionally, the latter’s Teladvance arm has a trade-in program to upgrade older phones through its retail customers.
The DGSE represents the majority of Envela’s income. Still, ECHG has much higher margins and that’s why the company has focused on expanding its presence in the e-commerce re-commerce market. Turning to Q2 2022 financial results, revenue was down 10% quarter-on-quarter to $42.6 million, but net profit was up 45.4%. This was mainly because ECHG’s revenue increased 5.7% quarter-on-quarter and its gross margin increased from 47.2% to 59.3%.
It appears high inflation and pressure from consumer spending are driving demand for refurbished electronics while negatively affecting Envela’s jewelry business, but I view this as a positive development as ECHG represents the major part of the company’s net income. Additionally, both segments continue to show rapid growth compared to 2021 results.
Looking ahead, Envela mentioned in its Q2 2022 financial report that it sees opportunities for further expansion through new openings in the US (page 25 here), so you can expect what the number of stores increases in the near future. The company disclosed in its second quarter 2022 financial report that it plans to make capital expenditures of approximately $1 million over the next 12 months (page 35). Additionally, Envela mentioned potential purchases of additional properties by the DGSE. ECHG, in turn, has historically relied on pursuing synergistic acquisitions and the latest included an IT asset disposal service provider To profit from in October 2021. I think Envela might be considering some smaller competitors as acquisition candidates at this time, as it had a large amount of cash on its books at the end of June. The company ended the second quarter of 2022 with $13.9 million in cash and cash equivalents, representing an increase of more than $2.4 million quarter-over-quarter. Net debt, in turn, decreased to $2.7 million from $5.3 million in the first quarter of 2022.
As you can see in the chart above, inventory went from $14.6 million in the first quarter to $17.8 million, but that was all coming from DGSE. ECHG inventory was down to just $1.8 million from $2.3 million three months earlier and that’s why I continue to believe that this subsidiary’s inventory supply is the biggest risk. for the bullish case right now.
Sure, Envela trades at just 7.8x EV/EBITDA based on Q2 2022 annualized results, but ECHG stocks were so low at the end of June that they only covered 12 days and 16 days of sales for the resale and recycling segments, respectively. I fear that a recession in the United States will lead to reduced spending in the education sector in the near future, which would further exacerbate the supply problems of the ECHG, as schools cling to old electronic devices.
As for other risks to the upside case, I think the other main one is that ECHG is a small business with high margins and no clear divide. In my opinion, it is possible that its margins will decrease significantly if a regional competitor emerges. A minor risk to bear in mind is that a significant portion of the DGSE’s inventory includes gold, which means that a sharp decline in the price of gold will put pressure on margins for this last for a short time.
Takeaway for investors
Envela posted a record quarterly net profit in the second quarter of 2022 thanks to the strong performance of ECHG, as it appears that the current microeconomic environment is driving demand for refurbished electronics. In my opinion, an EV/EBITDA ratio just below 8x seems low for a profitable and rapidly growing company.
However, ECHG stock levels are at low levels and there is no clear fluke, which is why I consider Envela a speculative buy. I think the company should be trading somewhere above 10x EV/EBITDA thanks to its compelling growth over the past few quarters.