RVLV - Revolve Group: Juggling Promotions Returns And Growing Customers

2023-11-16 22:06:59 ET

Summary

• Revolve Group faces challenges with declining Average Order Value, revenue, and net income YoY.
• The company is seeing success in segments like beauty and the Mexican market, as well as with AI integration.
• A decline in financials and a lack of optimistic forecasts for FY2024, suggesting a cautious 'wait and see' approach.

Revolve Group, Inc. ( RVLV ) is a profitable fashion e-commerce player, adept at sustaining cash flow even in challenging market conditions. However, its customer-focused strategy of free shipping and returns clashes with a promotional landscape, impacting its performance. In Q3 2023 , despite growing customer numbers and sales, there's concern over a 7% drop in Average Order Value (AOV), a 4% revenue dip, and a significant 73% decrease in net income YoY. The company faces challenges with shrinking gross profit margins due to discounts and reduced brand sales, compounded by rising return costs and excess luxury inventory.

There are positives in segments like beauty and the Mexican market, along with early wins from localised return policies and AI integration. AI's potential in reducing returns and creating popular fashion items, as well as the prospect of TikTok shops, offer promise, albeit at an early stage. However, the lack of optimistic forecasts for FY2024 raises investor concerns. Given this uncertainty, a cautious 'wait and see' Hold approach seems advisable.

Company overview

Revolve, a fashion e-commerce entity, boasts 2.5 million active customers, marking a 12% year-on-year increase. Its success in engaging Gen Z is evident through initiatives like TikTok sales and AI-generated fashion trends. The company operates under two segments: the original Revolve Segment, well-received with 6 million Instagram followers and positive Trustpilot reviews, showcasing a 55% gross profit margin; and FWRD, a newer, premium segment with under 1 million Instagram followers and comparatively lower Trustpilot ratings.

Revenue streams stem from own-brand sales, yielding higher margins, and third-party brands. While the US market sees a 5% revenue decline, international markets benefit from Mexican growth despite challenges in China and Australia due to economic strains and currency fluctuations. Notably, FWRD flourished during the cash-heavy spending period of COVID-19, although it experienced a 14% year-on-year decline, aligning with a broader 16% decrease in US luxury spending during Q3 2023.

Product-wise, a shift away from 'going out styles,' notably dresses, is evident, while the beauty segment thrives, marking a 44% YoY increase, constituting 4% of total sales—a category earmarked for potential expansion to 15–20% of total sales. The beauty industry, worth $430 billion and projected to reach $580 billion by 2027 , signals an upward trajectory.

High return rates pose a significant financial challenge. Efforts to curb costs via localised re-fulfilment strategies in the US, Canada, and the UK have commenced, with future plans for Europe. Technological advancements targeting size and fit accuracy, pivotal in reducing returns, are undergoing promising tests. However the increase in returns has not yet stabilised and continues to cut into overall performance.

Financial overview

The recent Q3 2023 Earnings report unveiled a 4% year-on-year sales dip, totalling $258 million—although a better performance than the preceding 6% decline. This decline signals caution for investors. However, the company’s resilience lies in its profitability and ability to generate cash flow, facilitating continual business reinvestment.

Despite a significant 73% YoY net income decline to $3 million, attributed to legal issues, the Adjusted EBITDA also fell by 46% due to lower gross profit margins influenced by market dynamics and consumer behavior incentivized by discounts.

On the cash front, the company showcased a 25% increase in cash from operations to $12 million YoY, with free cash flow soaring by 33% to $11 million. This financial strength enables debt repayment, business reinvestment, and investor rewards. Notably, Revolve initiated a $100 million stock repurchase program in Q2 2023, with $87 million still available, supported by a robust cash flow and healthy balance sheet.

The company’s focus on inventory rebalancing materialised in Q3 2023 with a 5% YoY inventory decline to $203 million. For the first time in two years, a healthier balance emerged, driven by a steeper decline in Revolve inventory compared to sales. However, the challenge of high inventory persists, particularly within the FWRD luxury segment due to reduced demand.

Valuation

Revolve stands out as a profitable fashion e-commerce amidst peers struggling to achieve similar earnings. For instance, Zalando ( ZLDSF ), with a market cap of $6.6 billion, isn't posting positive earnings. In my analysis comparing Revolve to counterparts like ASOS (ASOMF), Farfetch ( FTCH ), and The RealReal ( REAL ), it's evident that Revolve carries the highest price-to-sales ratio at 0.94 and the highest price-to-book ratio at 2.51. These figures potentially signify an overvaluation of the stock.

However, if we look at growth, while the company has had a decline in growth, its three-year average remains higher than most of its peers, not including The RealReal. Furthermore, while EBITDA has declined significantly, the others have yet to generate positive earnings.

As we know, the company's Ross profit margin has declined; however, compared to some of its peers, it is still attractive, although The RealReal has a much higher margin, as it sells high-end fashion items.

Risks

Revolve Group operates in the consumer discretionary sector, closely tied to economic health, particularly within the fiercely competitive fashion e-commerce industry. The current scenario faces pressures from high-interest rates, inflation, reduced savings, and amplified uncertainty amid macroeconomic and geopolitical shifts. Despite an uptick in customer numbers, there's a concerning 7% year-on-year decrease in average spending to $299. This decline, however, reflects market trends rather than dissatisfaction with the company's service. Furthermore, geopolitical forces, such as the Israel conflict, weigh on the company. A year earlier, the Middle East served as a robust growth driver for international sales, indicating the susceptibility of Revolve's business to global geopolitical events. As discussed earlier, the company has not managed to stabilise its rising return numbers, which are growingly costly.

Final thoughts

Considering Revolve's recent performance and market uncertainties, maintaining a 'hold' position seems recommendable. While the company sustains profitability and cash flow resilience, challenges like declining sales metrics, particularly in AOV, and significant drops in net income raise concerns. Positive strides in its beauty segment and AI initiatives provide promise, but the lack of upbeat forecasts for the future prompts caution. With ongoing challenges, especially in managing rising return rates, high inventory in its luxury segment and market headwinds incentivising a promotional environment, a cautious 'hold' approach seems advisable until clearer growth signals emerge.

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