REVOLVE ($RVLV)

Company:

REVOLVE is an upscale online fashion retailer for Millennial and Generation Z consumers. The company operates exclusively through an online channel and funnels customers onto their site by leveraging global fashion influencers, and emerging, established and owned brands. REVOLVE invests heavily into data analytics to monitor new fashion trends in order to have the latest product offerings for their customers. The company is headquartered in Los Angeles County, California.

Product:

REVOLVE sells a vast product mix. The company sells third party brand name clothing and makeup and also has several owned brands listed on their website. Across the product mix the margins on items are extremely different. For example, dresses have relatively high margins compared to other categories, such as beauty products, which have lower margins. Additionally, owned brands have generally contributed to a higher gross margin when compared to third-party brands hosted on the site.

Market:

Everyone knows that online stores have been dominating their brick and mortar counterparts. This trend is not likely to reverse anytime soon. REVOLVE is a part of this growing market segment, with e-commerce clothing expected to grow at an 8.8% compounded annual growth rate for through 2025. REVOLVE has no physical stores and the only real estate they own is a distribution center in LA.

Customers:

REVOLVE is the next-generation fashion retailer for Millennial and Generation Z consumers. Their target customers are females who have significant levels of disposable income. The average bill for a REVOLVE order is $275 and $232 for nine months ending in 2019 and 2020 respectively. The company had 1,438,000 and 1,504,000 active customers for nine months ending 2019 and 2020 respectively. During this time these customers placed a total of 3,623,000 and 3,476,000 orders for 2019 and 2020 respectively. The orders for nine months ending 2020 were more concentrated on lower profit margin items like make-up instead of higher profitable margin items such as brand owned clothing. The performance of the high end retailer throughout the pandemic shows customers love for the company and speaks to the strength of the brand.

The majority of customer traffic is derived from organic sources with unpaid social marketing and word of mouth being the largest sources of new customers. This speaks to the quality of the company and how individuals speak highly of the brand to their peers. In my opinion strong word of mouth marketing is far greater than any sales funnel or paid marketing.

REVOLVE also attracts customers via influencer marketing. They develop and maintain relationships with thousands of social media influencers and engage in sponsorship initiatives to draw their following onto the REVOLVE platform. Their paid marketing initiatives are further complemented by a variety of brand marketing campaigns and events. For example a major brand marketing event that has historically driven customer acquisition and demand for merchandise is #REVOLVEfestival. This year the company did not appreciate the sales boost from that festival due to Covid-19.

Overall the company’s performance throughout the pandemic has been impressive. It makes sense that overall sales are down given the nature of REVOLVE’s customers to spend significant money on “going out” clothing which wasn’t allowed this year. What matters more to a growth company like this is the 4.4% growth in new customers. It’s probable that the average basket value of each receipt will increase once consumers are willing to spend on “going out” clothing rather than just the essentials.

Opportunities:

Expansion into foreign markets:

REVOLVE recently offered higher quality service to international markets. For example, REVOLVE began offering a more localized shopping experience, including free express shipping, free returns and all-inclusive pricing, for customers in the United Kingdom and the European Union in May 2018, in Australia in late 2018, and free express shipping and free returns in New Zealand and Singapore in January 2020 and in Canada in October 2020. Net sales to customers outside of the United States contributed to 18.8% and 16.3% for the nine months ended September 30, 2020 and 2019, respectively. During the nine months ending September 30, 2020 and 2019, net sales to customers outside of the United States were $82.8 million and $73.7 million, respectively, representing an increase of 12.3%. If REVOLVE’s branding can establish the brand recognition it has in the United State in these new opportunity markets, the capital expenditure investments will be extremely worthwhile for the company. Growth of 12.3% is likely correlated to the companies newfound ability to offer free shipping and returns to customers in their identified opportunity markets.

Increase sales of higher profit margin Owned Brands:

One of the company’s long-term strategies has been to increase the percentage of net sales from owned brands given the attractive margin profile associated with them. Selling high profit margin products has an extreme effect on the companies earnings- I will show this in the quality of earnings section attached below. For example, a 3.02% difference in the cost of sales translates to a $0.07 difference in EPS.

Leverage information technology to increase supply chain efficacy:

The REVOLVE logistics network is powered by proprietary algorithms to optimize inventory allocation, reduce shipping and fulfillment expenses and deliver merchandise quickly and efficiently to our customers. The company holds very little inventory at any given time. This is a good thing, but if they are to continue this ‘just in time’ supply chain they must continue to focus on efficiencies relating to inventory management and supply chain management. The company has an ROA of 14.59% and inventory turnover ratio of 2.9. When comparing the ROA of REVOLVE to Stitch Fix, a company with a similar brick and mortarless strategy, REVOLVE’s ROA is 13.68% and 14.59% while Stitch Fix’s ROA is 5.99% and -8.72% respectively. Stitch Fix has a higher inventory turnover ratio, but this is because of the subscription box nature of the business. Most importantly however, REVOLVE’s EBITDA Margin is greater than twice that of Stitch Fix. REVOLVE reported an EBITDA Margin of 13.68% and 14.59% while Stitch Fix posted 4% and -3.41% for nine months ending in 2019 and 2020 respectively. This outstanding ROA and EBITDA Margin is powered by the company’s ability to leverage information technology to be an extremely lean enterprise.

Here is a comparison between Stitch Fix and REVOLVE on key operational metrics for retail companies.

RAW DATA: Figure 1

KEY OPERATING METRICS: Figure 2

Growth in FORWARD Segment:

FORWARD is REVOLVE Groups luxury item segment. REVOLVE represented 86.8% and 88.7% of net sales for the nine months ended September 30, 2020 and 2019, respectively. During the nine months ended September 30, 2020 and 2019, FORWARD generated $57.9 million and $51.4 million in net sales, respectively, representing an increase of 12.7%. Although FORWARD currently represents a very small percentage of total revenue, a 12.7% increase in net sales is significant. The company does not go into depth about gross margins relating to the FORWARD segment.

Threats:

Operational logistic facilities related to Covid-19:

The company’s sole fulfillment center is located in Los Angeles County which has imposed restrictions on businesses in an effort to slow the spread of Covid-19. This is a major bottleneck for the company. For example, if there is an outbreak of Covid-19 at their fulfillment center and they have to quarantine the facility, the company will not be able to deliver products to their customers.

Merchandise Mix:

Because the company sells so many products from beauty to owned brands to third party brands, the gross profit margin fluctuates based on consumer demand. If consumers do not buy REVOLVE brand products or higher margin items, the company will be hurt on an EPS basis. For example, when calculating the delta between cost of sales for 9 months ending 2019 and 2020, a difference of 3.02% in cost of sales represented an EPS impact of $0.07 a share. (I bring this up twice as it is an opportunity and risk).

Increase in Marketing expenses:

One of the companies main channels for marketing their products is via the use of social media influencers. These influencers are figureheads which they believe their target customers follow. Competition for social media and influencer-based marketing channels has been increasing in recent years which adversely affects the company’s operating results.

Tax rate changes based on equity option exercises:

The company’s tax rate was 25.94% and 14.32% for nine months ending 2019 and 2020 respectively. This dramatic decrease in taxes payable is related to the exercise of stock options. This is worrisome for two reasons. 1) a lot of the insiders are selling their shares, meaning that they believe the stock is overpriced or at least not undervalued. 2) The decrease in taxes is a one time non-recurring increase to EPS. The delta between effective tax rates is 11.62%, this works out to a one time increase in EPS of $0.07. Tax rate is extremely important for adjusting earnings of a company to be based on operational performance only. For the quality of earnings section I averaged the two tax rates and used 20.13% to adjust for the delta of pre-income taxable line items.

Financial Standing:

Cash

Cash equivalents were $132.9 million and $37.6 million as of September 30, 2020 and December 31, 2019, respectively. The company also touted a great free cash flow number of $74,383,000. Higher than Stitch Fix’s free cash flow value of $51,374,000. Yet REVOLVE’s market capitalization is around 4.17 times less than Stitch Fix’s.

Debt

REVOLVE has a line of credit $75.0 million. The company will pay interest at (1) a base rate equal to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate and © the LIBOR rate plus 1.00%, in each case plus a margin ranging from 0.25% to 0.75%, or (2) an adjusted LIBOR rate plus a margin ranging from 1.25% to 1.75%. The credit agreement also permits REVOLVE to request an increase in the facility by an additional amount of up to $25.0 million (in an initial minimum amount of $10 million and in increments of $5 million thereafter) at the same maturity, pricing and other terms. As of September 30, 2020, REVOLVE had $15.0 million outstanding on the line of credit. The weighted-average interest rate of debt outstanding at September 30, 2020 was 1.5%.

Dividends

The company is a growth company who will not issue dividends anytime soon.

Opinion:

The company is solid. I am extremely pleased by the company’s ability to have a similar operating performance across pre-covid and covid time periods. I believe that the brand is extremely strong and trusted by their customers. I am also impressed by the company’s ability to operate in a very lean fashion. They were able to eliminate and defer non-essential capital expenditures, significantly reduce planned inventory receipts and extend payment terms for both merchandise and non-merchandise vendor invoices.

The company beat earnings last November earning $0.27 per share. Wall Street consensus was around $0.14- $0.16. I conducted a quality of earnings analysis, to adjust line items to reflect the company’s performance strictly on an operational level and found that the company’s true EPS was $0.25. The two large line item changes across periods were changes in Cost of Sales and Tax Rate, negatively and positively affecting EPS by $0.07 respectively.

Now that we know that we know that the earnings of the company were growing because of fundamentals, it is worthwhile to create a bottom-up discounted cash flow model in order to provide price guidance. In a worst case scenario (as in the company will grow into the future with its worst operating results as a % of sales across the financial statements) the stock should be priced around $21. In a Base case scenario (as in the company will grow into the future with its average operating results as a % of sales across the financial statements) the stock should be priced around $57. In a best case scenario (As in the company will grow into the future with its best operating results as a % of sales across the financial statements) the stock should be priced around $100. I understand that these prices are extremely volatile, REVOLVE has only been a public company with financial statements that only go back to 2017. However it is clear that the company is stacking a lot of cash and can operate in an extremely lean manner. With capital expenditures managed for “the next three years” the company will continue to stack cash. I believe that the best way the company can utilize cash is to acquire strong brands in order to focus on lowering the net cost of sales.

I really like the stock, but right now there is no margin of safety related to the company’s current price. It is at an all time high, however I see the stock able to go much higher when compared to competitors like Stitch Fix.

Screenshots of the quality of earnings analysis are attached below.

Stitch Fix stock chart: 1 year

REVOLVE stock chart: 1 year