Description

SUMMARY

Revolve (RVLV) is an attractive long term investment from current levels as the company is a uniquely profitable online fashion retailer run by owner-operator CEOs with a history of guiding the company through difficult times and consistently growing the business. The company possesses a unique, difficult to replicate, and efficient business model, though one that is sensitive to prevailing consumer sentiment.

COMPANY BACKGROUND

The company was founded by two entrepreneurs to be an online fashion destination, improving upon the faults of traditional retail:

“We believed that traditional retail was either too mass or too limited, struggled to consistently provide ontrend merchandise, and was failing to connect with younger consumers. REVOLVE was created to offer a scaled, one-stop destination for youthful, aspirational consumers”

RVLV relies heavily on social media, Instagram in particular but more recently Tiktok as well, where hundreds of ‘influencers’ serve as marketers for the Revolve brand, selling private label and third party brands. The company also has a higher end property called FRWD, which sells more luxury brands and has 2.5x the average order value as the Revolve property.

Revolve’s clothing and fashion is generally considered to be higher quality than “fast fashion.” Revolve also holds a unique place in pop and fashion culture, collaborates with high level celebrities such as a recent Kendall Jenner collection, and holds an annual Festival around the Coachella festival which gathers celebs like Leonardo DiCaprio. I mention this to illustrate the company’s deep connections in the fashion and influencing, attributes that are key for apparel brands and are very difficult to replicate.  

Revolve turned 20 years old this year and since its founding in 2003, the company has grown largely organically – and with minimal outside funding - to now generate >$1.1 bn in sales with a long-term growth CAGR of >20%. The company has 2.4 mm customers in the TTM period, with a fairly high average order value of $288. The company was uniquely cash generative from early in its history as well as during the covid year, when management hunkered down to protect the business before enjoying the ensuing recovery in demand, particularly for “going out” attire.

BUSINESS STATS

US: 83% (of 2022 revenue)
International: 17%

Revolve: 84%
FWRD: 16%

Fashion apparel: 46%
Dresses: 30%
Handbags, shoes, accessories: 20%
Beauty: 3%
Other: 1%

Mix Commentary: In addition to margin recovery which I’ll discuss below, international sales offer long-term opportunity at just 17% of the total last year. Mexico and China were recently called out as showing promise. Beauty is also growing faster than company average and could evolve to a 10%+ sales category at high margins over time.

RECENT RESULTS AND FORWARD TRENDING

RVLV recently disappointed the market in their early May earnings release by reporting that 2Q QTD (April) revenue was trending down -7%, which management indicated was consistent with a broader weakening in the consumer during April. This is consistent with many other retailers as economic uncertainty, lower tax rebates, and some normalization from the prior year’s strong demand has occurred. Full year 2023 faces a difficult comparison as RVLV was a strong beneficiary of the post-covid back-to-work / back-to-play resurgence. Moreover, profits are being compressed by an overall unhealthy excess inventory position across retail and ensuing discounts coupled with renewed consumer hesitancy from uncertain macro. RVLV too saw their inventories become extremely bloated late last year but to their credit - and consistent with the vigilance previously displayed by the founders - has sought to aggressively rightsize inventory (sacrificing profits). As a result, RVLV’s excess inventory growth (adverse delta between inventory growth and sales growth) declined from a peak of 49% in 2Q’22 to just 7% this quarter. Management has indicated confidence that inventory will be rebalanced by the end of 2Q’23 (the current quarter), setting the company up for improved financial results in 2H’23. Gross margin, which has historically been near 54% is expected to be between 52 - 53% this year, though with an improving YoY derivative trend. Similarly, the company has recently seen elevated selling & distribution + fulfillment expenses as they still face some elevated shipping costs and inefficiencies in distribution from recent expansion which have both been exacerbated by elevated returns this year (FYI the company provides easy visuals and commentary on the trending of these expense items in their quarterly earnings presentations). Altogether, the sales and margin headwinds are causing a drop in ebitda margin all the way to ~5.8% this year. This compares to:

• ~9% in the pre-covid period
• 11-12% in the 2020/2021 covid/recovery year as the company sheltered expenses and benefitted from excess reopening demand
• 8% in the 2022 year as some of the issues I identified affecting recent results began to bite

I am optimistic on the margin recovery given management’s historical tenacity in managing the business and the clarity in which they’ve identified issues to improve. The tick-up in returns causes a meaningful profitability hindrance and the co-CEO has indicated that he’s now dialing-in on this issue, after a period of benign returns during which other priorities prevailed. Additionally, like other retailers, there is a line of sight into freight improvement. RVLV is also standing up and scaling new distribution centers in the Eastern U.S. and Europe which offer tangible margin improvement opportunity. Of course, while benefiting from an often obsessed customer base, Revolve’s category still remains highly discretionary in nature and so economic risk remains the key margin threat.

FOUNDERS

I have alluded to my high regard for the company’s founders, including their ability to grow the business to current levels with minimal outside funding, their preservation of capital during covid, and more recently their focus on correcting the overinventory error. It’s very unique for online retailers to show levels of profitability that RVLV has historically, let alone early in their development history. I think the founders deserve credit for this efficient business model and their ability to achieve fashion industry credibility as well as operational excellence. The backgrounds of the cofounders in data and technology (e.g., RVLV was early to capitalize on social media algorithms) are a key benefit. The story of the founder/CEOs and the business has previously been detailed here:

https://www.latimes.com/business/story/2019-08-23/revolve-clothing-instagram-influencer-ecommerce

The founders still own 45% of the company with what I’d consider minimal selling despite ample opportunity over the past few years, evidencing their continued incentives and ambition. This is a rare level of insider ownership and offers a further degree of comfort for the long term investor.

CONCLUSION

Given persistent macro fears and the recent slowing sales trends, a discretionary retail investment carries higher than normal risk. April sales down -7% is of course a key concern though, on the call, management did indicate that for the full quarter 2Q “it could be slightly negative to slightly positive.” Looking to 2H, consensus calls for modest YoY sales growth as comparisons become easier, but the market is penalizing any company with 1H->2H YoY growth inflection amidst the deteriorating consumer backdrop. With those risks stated, the company’s share price has been rapidly correcting. Short interest is very high at the company which feels inappropriate to me and could eventually fuel upside. For now, shorts remain in the driver’s seat yet my view is that management is moving fast on operational improvement (i.e., inventory, returns, logistics) and long-term underlying customer trends remain healthy (as evidenced by growth in TTM customers and four-year / pre-covid comp stacks). Despite depressed margins, the NTM forward P/E is at the bottom end of the five year historical range and even lower when considering cash has now piled up to 25% of the market cap. The multiple falls further (to ~15x on my estimates) when looking to the 2024 year (still unadjusted for the 25% cash position). 

Catalyst

- sales reacceleration
- short squeeze
- positive use of cash balance
- continued inventory improvement
- margin rebound