Online retailer RedEnvelope's (Nasdaq: REDE) ad campaign features a slogan that says: "It's nice to get a Red Envelope out of the blue." That must be how those who invested in the company earlier this year feel right now -- while this isn't a shooting rocket, the market's rising expectations of online gift-givers have certainly presented RedEnvelope shareholders with an early Christmas gift.
When I last wrote about the company, it traded below $10. Since then, even though there has been no substantial news, shares rose to a high of $13.80 right before Thanksgiving and have now settled into the lower end of the $11-$12 range. Should you sell, hold, or buy more?
Analysts estimate that this Motley Fool Hidden Gems recommendation will collect $43.5 million in revenues in the current Q3 2005, 21% higher than Q3 2004. This would be a lofty rise, but there is evidence that the company can deliver this kind of growth. In Q3 2003 RedEnvelope posted a 30% increase in total sales; more recently, in the previous two quarters, the company grew revenues by 27% and 19% and orders shipped by 18% and 15%, respectively.
It's worth noting that there are only two ways for RedEnvelope to boost revenues -- increased revenues per order and an increased number of orders. Last year, the price of each order shipped during the third quarter averaged $79, slightly down from $81 in Q3 2003. While a decline in this metric is usually problematic, in this case it was a result of RedEnvelope's switching to flat-rate shipping to remain competitive (most retailers -- such as Target (NYSE: TGT) -- make money on their shipping fees).
Still, the majority of additional revenues will be created by increasing the number of orders shipped. So if we assume that revenues per order will rise a modest 7% to $84.50, to meet the $43.5 million revenue estimate RedEnvelope would have to ship 515,000 orders in the current quarter -- a 14% increase from last year's numbers.
Is this plausible? In Q3 2004 RedEnvelope increased its total orders shipped by 7%, but this growth rate was lower because of fulfillment problems. How much lower we don't know because the company refused to divulge just how many orders were canceled in Q3 2004
So if you think that RedEnvelope has fixed its distribution and personalization centers, correctly specified its inventory levels and retained the trust of the two million souls in its customer file, you should hold or even add to the position. Personally, I remain skeptical and would prefer to examine the company from afar for at least another quarter. With the latest price run-up and the wallop that will follow if another miscue occurs I just don't see enough upside to justify dealing with such uncertainties. If you share these concerns you should probably sell and put the company on your watch list.
Fool contributor Marko Djuranovic does not own shares in any companies mentioned in this article.
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