RVLV - Revolve Group: A Mixed Picture

2023-06-28 10:49:27 ET

Summary

• Revolve Group, a fashion retailer primarily catering to young, aspirational shoppers, is leveraging digital and mobile technology to meet the unique fashion needs of millennial and Gen Z customers. Despite this, the company's stock has contracted by 54% since its listing in June 2019, underperforming both the ProShares Online Retail ETF and the broader SPDR S&P Retail ETF.
• We touch upon a few key operating metrics that could weigh on the share price.
• Despite the erosion of wealth so far, RVLV's stock could be attractive for those looking for short-covering opportunities, with the percentage of the company's float, which is short standing at 54%. However, the stock is not particularly cheap to own, and it's unlikely that value-conscious investors would be tempted to pay P/Es of over 25x for a business unlikely to provide any earnings growth over a two-year time frame.

Niche Positioning, But So Far, The Market Has Looked Away

Revolve Group (RVLV) with a two-decade-long history in the field of fashion retailing, primarily caters to young aspirational shoppers. RVLV's product mix primarily revolves around apparel and footwear, although it also offers beauty, home products, and accessories.

The company's USP is centered around leveraging digital and mobile technology (last year, sales via mobile devices accounted for roughly two-thirds of group sales) to cater to the unique fashion needs of aspirational millennial and Gen Z customers. This potentially lucrative cohort (for context, millennials' share of US housing net worth has grown by 50% over the last three years) often fails to garner focused attention from national retailers or department stores, who prefer to hedge their bets and service a broader demographic by offering fairly generic assortments. RVLV's focused positioning appears to be gaining popularity in the market with its active customer base currently trending up at a run-rate of almost 20% YoY!

Revolve's retail operations are also underpinned by an automated data-driven merchandising model that enables the company to adroitly pick up on new trends or styles that also have a low risk of attracting the attention of other retailers. Interestingly enough, RVLV only makes its merchandise available in limited quantities, and refreshes it quite frequently (typically on a daily basis), thus triggering a degree of FOMO within its target audience that are often susceptible to bouts of instant gratification.

Despite a relatively niche positioning, it's fair to say that the market doesn't think much of the Revolve story. Since the stock's listing date in June 2019, RVLV has proven to be a source of wealth destruction, contracting by -54%, and also underperforming both the ProShares Online Retail ETF (ONLN), and the broader SPDR S&P Retail ETF (XRT) in the process.

Could this long-term trend reverse in the months ahead? Well here's a discussion of some key metrics to monitor that could weigh on the stock's prospects

RVLV - Key Operating Metrics

RVLV's topline trends have turned awry this year, with softness being witnessed across the board . It's difficult to see a reversal in the near term given the unfavorable conditions for discretionary-related purchases. For context, management had previously highlighted how growth for the first seven weeks of the year had come in at mid-single-digit levels, but the last six weeks of Q1 proved to be a dampener, with the exit rate in April coming in at a sizeable decline of -7% YoY.

The latest US Census data for the apparel sales category showed that industry level numbers declined by -0.2% YoY last month, and it's difficult to imagine RVLV bucking this negative growth trend unless it engaged in more pronounced discounting or promotions.

Whilst one cannot rule out some marginal degree of promotions, we don't expect this to be a dominant theme in Q2, as RVLV's days in inventory is already quite close to dropping to its 5-year average.

For additional context, note that around a year back, RVLV was boosting its inventories at a much higher pace than what it was selling, but lately the variance in the respective growth rates has narrowed to just -7%.

On the Q1 earnings call, management noted that they would likely hit a balanced inventory position by the end of Q2 .

With the inventory position close to normalizing, one does wonder if RVLV will have alternative levers to keep its free cash flow momentum chugging along. If RVLV can continue to generate higher FCF, and then you combine that with its ever-increasing cash balances (which are nearly $300m now), one could perhaps kickstart conversations about supporting the stock via a share buyback program.

In Q1 alone, the company generated $48m of FCF, over 2x the cash-flow generation seen across the whole of FY22. However, note that 52% of the FCF generation was driven by inventory reductions, and it's difficult to envisage yet another quarter of such strong cash inflows due to inventory optimization.

On the flip side, with a lower level of markdowns, and potentially better full-price dynamics we think RVLV's gross margins ((GM)) could start trending up. In Q1, the GM picture was quite disastrous with the margins slumping by roughly 500bps YoY to hit 49.8%. Management expects a sequential recovery in Q2, with margins closing the year at around the 52-53% mark.

Closing Thoughts

Revolve's stock may have eroded wealth so far, but at this juncture, one shouldn't cast aside its allure to those fishing for prospective short-covering opportunities. As things stand, the percentage of RVLV's float which is short stands at a whopping 54%, the highest it's been in three years!

Meanwhile, we also have a steep days-to-cover ratio that is now close to hitting double-digit levels. If a few bullish catalysts were to germinate (say, positive surprises on the GM, or a potential buyback program given improving cash-gen and record high cash balances) and gain traction, it wouldn't take much for the formation of a quick uptrend, particularly as RVLV's stock already looks like one of the chief mean-reversion plays within the retail sector. The image below captures the relative strength of RVLV as a function of the SPDR S&P Retail ETF ( XRT ); note that the ratio is currently at record lows, and is around 3x lower than the mid-point of its trading range.

Having said that, do also consider that this is not a particularly cheap stock to own, and we can't see value-conscious investors jumping in at this juncture.

Based on the FY23 EPS estimate ($0.5922, which implies YoY decline of -30%), the stock is currently priced at 26x forward P/E, and even if RVLV benefits from the low base effect and witnesses earnings growth in FY24, do consider that the absolute EPS estimate in that year still looks poised to be a tad lower than what we saw last year. Would investors be tempted to pay P/Es of over 25x, for a business that is unlikely to provide any earnings growth over a two-year time frame? Unlikely.

Then, if we shift focus to RVLV's weekly price imprints, it's difficult to spot any faint bullish signals; in fact, it's the bears who have the wind in their sails.

Between May 2022 and April 2023, it looked like RVLV was attempting to build a base between the $22-$32 range. However, since April, we've seen a breakdown from this range, with the latest price imprints representing a bearish pennant pattern .

We would only gain confidence in RVLV if it can recoup the old trading range, and then pull back again to form a base at slightly higher levels without re-testing the 52-week lows of $14.95.

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