Revolve: The New Macy’s
We all know traditional retail is dying. Well, specifically, traditional department stores won’t be around much longer. Macy’s, JC Penny, even Nordstrom’s. They’re all dead stocks trading. They didn’t evolve for the digital age and are now left with giant empty stores in giant empty malls across America.
But just because these department stores are going out of business doesn’t mean people are going to stop shopping for clothes. Yes, in 2020 there will be a slowdown in apparel sales with people staying inside for the next few months. Industry estimates will be missed. But eventually, once the economy recovers, people will still buy clothes. In fact, it is estimated that on its own the United States fashion e-commerce market will be over $100 billion a year by the end of 2021.
And it won’t just be Amazon leading this charge. There is a certain portion of the population (10 million? 50 million? I don’t know the exact number, but it is large) who won’t buy Amazon Basics clothing. They’re the Costco jeans of online apparel, not the Macy’s or Nordstrom’s.
In steps Revolve. The self-described “next-generation fashion retailer for Millennial and Gen Z consumers” is replacing the void being left by the old-style department stores. But is the stock a buy here? Let’s investigate.
(Check-out my investment process here).
Financials/What They Do
Let’s go through a few more details on how Revolve’s business operates because it is fairly simple. They are essentially just a fashion website that sells thousands of their own and other brands at high prices. Besides the main site, they also own Forward, a “destination for all things luxury,” and have an Instagram account with 4 million followers that they use to directly sell to users.
According to their S-1 (they’ve been public for less than a year), Revolve’s marketing strategy consists of paying thousands of global fashion influencers to wear their brands and convince their followers to do the same. I usually roll my eyes at the “influencer economy,” but this is how Nike got people to wear their shoes (with athletes) and think it could work with millennial women on Instagram.
As far as financials go, in 2019 Revolve had $601 million in total revenue that was growing 21% YoY. Stated gross margins were 53% (down to 35.7% if you include fulfillment in cost of revenue, which I think you should), and they generated $33.6 million in free cash flow in 2019.
Right now their market cap is $577 million, giving them solidly low multiples when looking at a trailing basis. Obviously, sales/profits will be hit this year, but it looks like they have a balance sheet that can weather the coming storm. According to their investor update on March 20th, as of the end of February, the company had $85 million in cash, a substantial amount for someone with only $100 million in current liabilities and over $104 million in inventory as of the end of 2019.
If things get tough for a long time Revolve may need to raise some debt or do a share offering, but as of right now I see zero reasons to be concerned from a liquidity or valuation standpoint. In fact, I see both as being quite strong.
Do I Understand the Business?
I have this question mainly for software/technology companies when the value proposition or business model is hard to grasp. For Revolve it is the complete opposite. All Revolve does is sell clothes/fashion accessories to rich kids through an online store. That part isn’t hard to grasp.
What is difficult about this business is convincing people to buy through your site over the hundred other options on the internet. Which is why I always ask…
Do They Have Competitive Advantages?
Revolve has a structural advantage over traditional clothing retailers because it doesn’t have to operate physical stores. It can be quick and nimble with its inventory decisions, making it not only asset-light (for a retailer at least) but also more on top of what is happening in the fashion world. Macy’s just can’t keep up.
But how does Revolve beat other online retailers? Well, first off, by doing the Nike model for Gen Z fashion. Nike dominates the athletic shoe industry because they pay top athletes to wear/market branded shoes for them. The same goes for Revolve and fashion personalities on Instagram. These people, whether you think they’re just grifters, can have millions of followers who will buy whatever they’re wearing.
Paying these influencers, building the brand flywheel, and getting consumers to idolize the clothing Revolve sells is how they will bring shoppers in. And they will keep them around with their new loyalty program, just launched this year. It is free and does not have an attached credit card (at least not yet), and is essentially a frequent flyer program for Revolve/Forward customers. Learning from successful retailers of the past (one of which was Macy’s), these programs are how stores build a moat and keep customers coming back again and again.
What Their Industry is Like
We’ve gone over a lot of this in the intro, but let me reiterate that while there may be a short-term “stay-at-home” headwind for fashion retailers, there is a huge long-term tailwind for online stores that under-30’s love.
Macy’s brings in around $25 billion in sales every year. Once that goes away, some other company can pick that up. Whether it is Amazon, Stitch Fix (another stock I own), or Revolve, that $25 billion in apparel spend has to go somewhere. I’m betting Revolve can at least get some of it.
Vetting of Management
The management team at Revolve checks off a lot of boxes. For one, they are still founder-led (two co-founders), who have proven they can work and grow a company together since 2003.
As well, they seem to have the long-term vision I want as a shareholder. From their recent conference call:
“We have a tremendous opportunity in front of us, and true to our entrepreneurial, founder-led spirit, we will continue to be relentless in building a growing and profitable business for the long-term. I’m confident that by executing on these 2020 initiatives, we will be stronger than ever and well-positioned for our next phase of growth.”
One negative would be the company’s Glassdoor ratings. Overall it was only a 3.4 and it seemed like a lot of ex-employees were upset with their pay. However, management had an 80% approval rating, which is solid.
Is There a Scenario Where They Beat the Market?
Let’s assume Revolve can eventually grow into a $10 billion revenue business. That is over 10x what they bring in right now, so it won’t be anytime soon, and I have no predictions on the exact date on when it will happen, but let’s just think about it anyway.
We also should think about gross margins, and then eventually net/cash flow margins. Right now, Revolve’s gross margin minus shipping/fulfillment is around 35%. Chop off another 10% for sales and marketing (it is at 15% of revenue right now) and 10% for administrative expenses and you end up with 15% operating margins. We don’t know their exact tax rate, but let’s just say it will be 20%, which gives them a 12% net margin. On $10 billion in revenue, that is $1.2 billion in profits they could be bringing in annually.
A lot of assumptions, I know, but that could mean at least a $15 billion market cap for the company, and even more if they are converting a lot of that net income to free cash flow. Right now they trade under $600 million.
2020 will be a dicey period, and there is no guarantee that Revolve will ever reach $10 billion in annual sales. However, a lot of things are lining up in Revolve’s favor, and if they can take advantage of them, we may look back and realize this was the department store replacement people were looking for.
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.