Brilliant Earth Group: A Diamond in the Rough

Brilliant Earth Group (BRLT) is an innovative, digital-first jewelry company. It offers exclusive designs delivered to customers through a highly personalized omnichannel experience. It focuses on one operating and reporting segment, which is the retail sale of diamonds, gemstones, and jewelry.

We are bullish on the stock because it is a very efficient company that creates value for shareholders. In addition, we believe the stock is undervalued.

Recent Earnings

Brilliant Earth reported a strong first quarter for 2022. Revenue came in at $100 million, beating the consensus estimate by $2.12 million. This equates to an increase of 41.5% year-over-year. Furthermore, non-GAAP earnings per share were in line with expectations at $0.05.

Unfortunately, the stock took a big tumble after the earnings report. The reason for the drop was that the company lowered its guidance for Fiscal Year 2022.

Management had initially expected revenue of $485 million to $500 million and adjusted EBITDA of $51 million to $55 million coming into the year. It now expects revenue of $450 million to $470 million and adjusted EBITDA of $30 million to $40 million.

Measuring Efficiency

Brilliant Earth needs to hold onto a lot of inventory in order to keep the business running. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting its success. To measure its efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:

CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding

Brilliant Earth’s cash conversion cycle is 15 days, meaning it takes the company 15 days for it to convert its inventory into cash. This is better than the consumer discretionary sector average of 32 days, meaning that the company is more efficient than most of its competitors at converting inventory into cash.

In addition to the cash conversion cycle, let’s also take a look at Brilliant Earth’s gross margin trend. Ideally, we would like to see a company’s margin expand each year. This is, of course, unless its gross margin is already very high, in which case it is acceptable for it to remain flat.

In BRLT’s case, its gross margin has increased in the past several years, from 42.2% in 2019 to 50.1% in the last 12 months. This is ideal because it allows the company the opportunity to increase free cash flow or reinvest a larger percentage of its revenue into growth initiatives.

BRLT Creates Value for Shareholders

Great companies often have great management teams that can effectively allocate capital to profitable projects. Many professional fund managers tout the importance of meeting with a company CEO to gauge if that person is right for the job.

However, we may be able to get a good picture of management’s effectiveness by simply looking at the numbers. A metric we like to look at is the economic spread, which is defined as follows:

Economic Spread = Cash Return on Invested Capital – Weighted Average Cost of Capital

Here’s how it works; if the cash return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.

For Brilliant Earth, the economic spread is as follows:

Economic Spread = 31.2% – 11%
Economic Spread = 20.2%

As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.

Potential Headwinds

The main headwinds the company is facing are the geopolitical and macroeconomic environment. The longer inflation rages on, the more likely consumers are to reduce discretionary spending on things such as jewelry.

Furthermore, the Federal Reserve has been quite vocal about its intentions to stamp out inflation, citing a series of rate hikes and quantitative tightening in order to achieve its goal. The risk here is that the Federal Reserve might be too aggressive, which would plunge the economy into a recession.

Thus, retail companies like Brilliant Earth would be impacted by a slowdown in spending.

Wall Street’s Take

Turning to Wall Street, Brilliant Earth has a Strong Buy consensus rating based on four Buys, zero Holds, and zero Sells assigned in the past three months. The average Brilliant Earth price target of $11.25 implies 184.80% upside potential.

Analyst price targets range from a low of $10 per share to a high of $13 per share.

These four analysts reiterated their buy ratings after the earnings report came out. This demonstrates that they believe the recent sell-off was an overreaction by investors, which could provide an interesting opportunity for contrarians who are willing to enter at these suppressed levels.

Final Thoughts

Brilliant Earth is a strong consumer discretionary company that has been heavily punished for lowering its guidance. However, its new guidance still equates to an increase of 23% year-over-year at the consensus estimate. In addition, earnings are expected to grow significantly faster.

Even if a recession does hit, it won’t last forever, and the company has the margins and asset-light business model to easily weather the storm. Furthermore, we believe that a worst-case scenario might already be priced in at the current price of $3.95 per share.

As a result, we are long-term bullish on the stock.

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