You’ve probably already heard that China has posted another startling GDP growth
figure. But something you probably don’t know is that this country of over 1.3
billion people has grown at an annualized rate of 9.7% for a mind-blowing 28
years!
This level of growth over an extended period has had the lasting effect of
creating new levels of wealth in China. With wealth creation comes broad shifts
in spending as a percentage of per capita income away from sustenance and basic
goods and toward luxury goods. One such luxury good is jewelry.
Hong Kong-based LJ International (Nasdaq: JADE) is a company that stands
to reap the windfall benefit tied to Chinese citizens’ newfound discovery of
discretionary income. LJI is a vertically integrated jewelry company that
sources, designs, manufactures, distributes, markets and sells fine jewelry
products with an emphasis on colored and high-end precious stones. The company
boasts over 18,000 new designs per year and consistently offers over 50,000
designs.
The firm’s business model is two-tiered with both a wholesale business and a
retail chain, with a fiscal year 2005 revenue mix of 97% and 3%, respectively.
One facet of the firm that makes it highly unique in its industry and gives it a
clear competitive advantage versus its peers is its “mine to market” strategy.
The “mine to market” strategy refers to vertical integration and gives LJI the
advantage of cutting out nearly all middlemen across all levels of the supply
chain, thereby allowing the firm to internally capture profits from every level.
Participation at every level also affords LJI tighter quality control, the
ability to produce larger quantities and lower costs, making it aggressively
sought out by larger retailers.
The firm’s supply chain segment currently focuses on North America and includes
27 of the top 40 U.S. jewelry retailers. The ranks of LJI’s customers include
$100 million Supersellers such as retailers like J.C. Penny, Macy’s, Wal-Mart,
Kohl’s, Zales, and Sterling, and home-shopping television networks such as QVC,
HSN and ShopNBC.
LJI recently entered into the Chinese retail jewelry business by way of the
launch of its ENZO retail store line in November of 2004. ENZO provides a
complementary and higher margin growth opportunity capable of capitalizing on
China’s booming middle class and an estimated $20 billion-plus jewelry market.
The ENZO line has grown quickly to 35 stores and is expected to expand further
to 100 stores by the start of the Beijing Olympics in June of 2008, for a three
year CAGR of 70%. Almost half of the ENZO stores are already profitable and
existing store revenue per square foot has increased from 2005 to the first half
of 2006 at an annualized rate of 31%.
For the last three years LJI has been posting impressive top line growth, with
revenues rising from $58.2 million in 2003 to $77.4 million in 2004 (+32.9%) and
$94.6 million in 2005 (+22.2%). Annual earnings have also grown over the same
three year time period, from $1.0 million or $0.11 per diluted share in 2003 to
$2.9 million or $0.26 per diluted in 2004 (+197.3%) and $3.4 million or $0.26
per diluted share in 2005 (+20.2%).
In the recently reported second quarter of 2006, revenue grew 36% to $26.0
million from $19.1 million in the year ago quarter. Similarly, revenues grew
7.4% on a sequential basis from $24.1 million in the previous quarter. Growth of
the company’s ENZO line drove the revenue growth in the most recent quarter.
ENZO sales totaled $2.69 million, up 53% from $1.76 million in the previous
quarter. ENZO revenues were not a significant factor in the year ago quarter.
Second quarter earnings doubled to $0.6 million, or $0.04 per diluted share from
$0.3 million, or $0.02 per diluted share in the year ago quarter.
At a price of $4.27, the firm’s shares currently trades at 15X the current year
consensus analyst estimate of $0.28 per fully diluted share and 12X the forward
year consensus analyst estimate of $0.36 per fully diluted share. We hold shares
of LJ International in our Rising Star Stocks portfolio, and rate shares a Buy
with a share price target of $6.00. We arrived at our share price target
applying a pricing multiple of 22X current year earnings, which is in line with
the industry average. This represents price appreciation potential of 41% from
the recent price of $4.27.
