What Investors Need to Know About Revolve Group

In this episode of Industry Focus: Consumer Goods, Emily Flippen and Motley Fool contributor Asit Sharma take a deep dive into Revolve (RVLV -1.46%), a high-end fashion retailer focused on millennials and Gen Z. They discuss the company's operations, its unique marketing approach, what gives it an edge over competition, how it's expanding, and more.

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This video was recorded on Dec. 8, 2020.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, December 8th, and I'm your host Emily Flippen. Today, I'm joined by The Motley Fool's Asit Sharma to take a look at Revolve Group, and Asit and I are actually prerecording this on the November 24th, but the good thing about Revolve is, as hopefully you'll see throughout this episode, is just how evergreen this company is, really long-term tailwinds, so don't worry too much about, you know, the 10 or so days missing. [laughs] I promise it's still relevant.

Asit, thank you so much for joining.

Asit Sharma: Thanks, Emily. And if I can refer to another recent episode, thanks for taking a bet on me for this episode, I think we're going to have fun.

Flippen: This is actually a company that you want to talk about. And I have to admit, when I started to do my initial research here, I was a little surprised, I mean, Revolve Group, to me, sounds like a company that would do a really great job at, like, rotating your tires or something, and it's, you know, needless to say, that's really not the case. Revolve Group is, self-proclaimed, next-generation fashion retailer for millennial and Gen Z customers, therefore, I should really know more about this company than I do. Unfortunately, I'm not really into fashion, and Revolve operates this really high-end fashion platform that appeals to people who are looking to purchase higher-end clothing products, jewelry, bags, those sorts of things online.

Just to show you how premium this is, the average order volume for an average of all customers in 2019 was around $275 per order. So, it's not in the thousands, right, it's not Gucci, for instance, but it's also not your average department store, it's not somebody who's buying clothes at Target, or Walmart, or Burlington, these are higher end brands.

And the thing that really stood out to me, and I'm not sure if this is also what stood out to you, Asit, it was just all the brands that are uniquely owned by Revolve. I mean, I know the platform space right now for clothing is really interesting, but Revolve I think sets itself apart, because what they do is they collect data analytics on their millennial and Gen Z customers and they use those buying patterns to then roll out their owned brands, their own premium brands. And it's so interesting, because 36% of sales last year were from brands that were owned by Revolve. So, I'm really happy that you brought up this platform for us to talk about today, because it's not what I expected, right, they're not rotating my tires, but they're also just not another one of these, say, Net-a-Porter or something, where you're buying really expensive clothes online. They're actually collecting a lot of really interesting information and data about their customers, that it's one that I'm excited to dig into deeper with you.

Sharma: Yeah, I was going to try to fool you further, when we were first talking about this, by saying that they made turntables, but I decided against it. Didn't want us to get too much into the research [laughs] in cross wires. [laughs]

Okay. So, well, let's jump into the business model then. Emily, you mentioned, so there are many well-known names in this space, like, Farfetch, The RealReal, etc., and there has to be something different about Revolve for them to make their name in the market. And that different thing is that they've constructed their business model around influencer culture. It's considered a pioneer in the use of social media to harness sales. The company has been around since 2003, had its recent IPO in June of 2019, and over that time it really was, sort of, farsighted in gathering together a network of influencers. Its network is now about 4,500 global influencers strong. And these influencers draw customers to the platform, basically.

What's really interesting about Revolve is that they use an event-driven approach to marketing. And this is something I really didn't realize, I looked at the stock briefly before it went public and it wasn't until a few months ago that I finally got it. [laughs] They rely on all kinds of events, some of which have become Revolve events, so their own branded events around the world. And they use all the youth that goes to concerts and music festivals and they're posting to Instagram and Snapchat and other social venues, they use that to create buzz and drive engagement to their brand, at which point they try to convert some of that traffic into sales, which they've been really good at.

Just wanted to mention one statistic here. Last year they generated about half of their traffic, 51%, to their Revolve website through free or low-cost sources. So, that's the buzz. And you know, I'm surprised, Emily, too that you don't know this more, because maybe this is something that would be a bigger name, I would think, for younger people, even if you weren't a fashionista, just from the amount of buzz they try to create, but I hadn't heard of it either, not that I'm ...

Flippen: [laughs] I'm getting such a good chuckle from this, I thought that after doing all these episodes we would understand each other better, Asit. All you have to know is that, you know, the only influencer in my life is, like, David Gardner and Warren Buffett. [laughs] So, I'm not that tuned into the influencer culture. So, all you need to do is say Revolve is driven by influencer culture; I was like, yeah, I'm probably not going to know it.

Sharma: [laughs] I should say that you are an influencer in the investment world, Emily ...

Flippen: Aw! You're too kind.

Sharma: [laughs] But I guess neither of us, right, know much about fashion, and that's why it hasn't been top of mind. So, going back to how they convert. After they get people onto the platform, they do actually use some paid traffic, some targeted marketing efforts, paid search and product listing ads, affiliated marketing, all kinds of things to help conversion.

You mentioned that data-driven platform. Just to give you a flavor of that. So, in the 17 years the company has been around, they have put out hundreds of thousands of styles on their website with up to 60 unique attributes per style that they log in their databases. And so, they have what they call hundreds of millions of data points, and that helps them optimize what products to offer, as well as how to really focus their marketing efforts, again, to drive conversion and to bring new users.

The thing that I really like about this site is the Revolve brand itself. And I think you've already mentioned this that with each year they have an increasing amount of Revolve-branded merchandise. The thing I love is that it sells for similar price points to the brands that we all know. So, Revolve, for the younger generation, is becoming a brand name in and of itself. So, those statistics that you mentioned, owned brands representing 36% of total sales in 2019, I think those are going to grow in the future; and we'll get into this a little bit later in the podcast. They've taken a bit of a hit on owned brands this year because of COVID, but like every other company, certain things have faced headwinds and certain things have really worked well for them in terms of merchandise offerings, but we'll talk about that in just a bit.

Flippen: Yeah, it's such an interesting platform. And I have to be honest, when I realized what Revolve was, I mean, I was familiar with Farfetch just from previous research, Net-a-Porter, all of these platforms that connect high-end luxury goods with the end consumer. And it was interesting to me, because when I went on Revolve's platform, the average price point that I was seeing for a lot of their clothes were, you know, maybe $60, $80. Again, not cheap, but if you're listening and you're sitting around the computer or something right now, I encourage you to just navigate to one of these sites and take a look, because you can see a fundamental difference between what Revolve is targeting as a customer versus what Net-a-Porter is targeting as a customer. These are sites selling thousands of blouses for thousands of dollars, right? Giovanni or Givenchy, I don't know my brands clearly, very high-end luxury brands versus higher-end, but not quite premium luxury, which means that there's an opportunity for Revolve to get into this space with their owned brands once they have customers pulled in.

And that's interesting, it's compelling to me as an investor, but at the same time I have to wonder, with the average order volume being so much lower than that of competitors, I think Farfetch, for instance, is around $600 per order compared to their $275 per order. It also means that their customer is just not quite as lucrative. So, they have to be really careful about their marketing spend and how much money they spend to bring somebody on to the Revolve platform, because they can't spend $300 to get that person and have a [laughs] 50% margin the way that Farfetch can, they have to be much more frugal about it.

And they have been. I think the influencer culture is so interesting, but at the same time, hasn't COVID shut down that? I mean, are people still buying clothes, are people still going to events during these times? I mean, surely there has to have been an impact from the past eight months on this business.

Sharma: For sure. And I think the answer is that people are still buying clothes, but the nature of the clothes they're buying has changed. You know, the pandemic basically brought all these music festivals, travel, social gatherings to a halt, and that shut down Revolve's primary method of content generation and bringing people to their site. They had to make a really quick pivot to live video content shows. And I really applaud management for this. They did this, you know, in a matter of weeks. They started moving all content to, sort of, live venues over video; [laughs] very socially distant there. They got fashion designers, celebrities, their influencer partners to do numerous shows, and they garnered about 11 million views within just a few months in the Spring and Summer of this year. So, they were actually able to save their revenue profile, they didn't grow revenue, but it only slipped 3%. In the first nine months of this year revenue is down to $440 million; that's just a 3% drop.

And you sort of alluded to this, Emily, they're selling more beauty and loungewear today than they [laughs] were this time last year. So, the emphasis on the luxury goods, the really cool clothing that you're going to wear when you're going with your friends to have a fun evening out, that's declined, but they are really killing it on makeup, and accessories and just clothes that you feel comfortable in. Now, that has pressured the average order value, it's down to $232 in the third quarter of 2020. But surprisingly, with that slip in average order value, with the small slip in the topline, operating income has actually improved by $7 million in the first nine months of this year to $44.4 million.

What's the reason behind this? Well, the biggest reason, I think, is that management, the two CEOs – so, this has a Co-CEO structure.

Flippen: Oh, really? I totally missed that in my research. That's so interesting.

Sharma: It's really interesting, because they're also the two Founders of the company. And give me a second, I'm going to grab their names for those of you who are interested in following up on this, the two CEOs are Mike Karanikolas and Michael Mente. So, these were friends who started this business, as I said, in 2003 ...

Flippen: They're both named Michael?

Sharma: [laughs] They're both named Michael, they both love fashion, they both are Co-Founders, both are Co-CEOs even today. So, they obviously [laughs] work really well together. But they are obsessed, Emily, with inventory management and all the unglamorous parts of running a fashion business. One of the things that they spent an inordinate amount of time with last year was the fulfillment and distribution center, the primary one, that Revolve uses. They invested in that. And this year, they're on to the next phase from, really, expanding that distribution center to automating it. And that really served them well this year. Their inventory turns – so, how many times do you turnover inventory in a year, faster is better – has increased to the fastest pace in years, sort of like what it looked like when they were a much smaller company. And even though they've had compression on their sales, the toplines decreased, as I said, the average orders decreased.

Gross margin is actually improving, it's up two whole percentage points in this last quarter to 55% versus the prior year. So, paying attention to the details of the business, and also using all the strong data analytics they built up over the years, in a way this reminds me a little bit of Stitch Fix, Emily, and how interested they are in technology. That's really helped them. And so, just a couple more points on these financials. They were profitable before the pandemic, and they've been profitable and cash flow positive, both, before and this year. So, in the first nine months of this year, they've had $38 million. And net income dropped to the bottom-line versus $27 million last year in the same period. And operating cash flow has surged last year, in the first nine months it was $32 million. They've generated $76 million of operating cash flow in the same period this year.

So, I really like how solid they are, just lastly, to mention, they've got $143 million of working capital on their books and no long-term debt. So, maybe there's an advantage here that they can parlay. They are a little bit slower growth, and just not as [laughs] top of mind as those more glamorous platforms like Farfetch, but there's some stuff here to like.

Flippen: I want to go back to the inventory turnover. I didn't know that, and I want to just highlight how impressive that is. You said, it was their fastest inventory turnover rate in five years during this pandemic?

Sharma: Well, they didn't disclose but they said, several years. And if you go back and, sort of, look at their inventory turns, I'm guessing it's at least five years, resembling what they looked like probably when they were much smaller.

Flippen: So, that is absolutely mind-blowing to me, because think about what you have to do as a retail business, it was the downfall for businesses like J.C. Penney, contributes to losses at businesses like Kohl's and Nordstrom, it's that they have to predict what is needed and desired by the customer and have that in stock, but not have too much of it in stock that they're left carrying all of this inventory for months or years afterwards. So, I would have thought that heading into 2020 a company like Revolve would be stocked up on business clothes, for instance, or cloths that -- jeans, things that normally are in high demand. And then all of the sudden March hits, people are stuck at home, nobody is putting on pants anymore, you're not thinking, I need to go out and buy a new pair of jeans because I've grown three inches in my waist, you're thinking maybe I'll just get a pair of sweatpants.

My presumption heading into this would have been that Revolve would be sitting, like a lot of businesses, on a ton of inventory that they just can't sell through, but the fact they've had such high inventory turnover, to me, is a signal to this other point I'm going to make about the customer and just how sticky the customer is that they come back to the Revolve platform and they're buying, they're doing a great job in managing their inventory and they're doing a great job retaining those customers. What I thought was really interesting looking at this business is that, 45% of their customers are existing customers, that's up from 41% in 2018, marginally, that was 2019 numbers.

But what's really interesting is that 45% of customers in 2019 were 74% of sales in 2019. So, the customers that they're retaining, granted they're only retaining about 45%, right, that's our core customer base right now. They're not retaining at the highest level, but the customers that they are retaining are spending a lot more.

So, I presume, [laughs] and I could be wrong, but I presume it's those existing customers that were largely responsible for the really high levels of inventory turnover during this pandemic.

Sharma: Oh, for sure. And it's a really good point, because if you're going to have customer churn, you can accept a little bit of churn, but if you know that you're going to retain the highest value customers, you can accept a much bigger number. And that's sort of what they're doing. The other thing which we should give management credit for is they just really made some tough decisions.

So, I mentioned this earlier that we would talk about this really briefly. Those owned brands that you and I both like the fact that they have grown that to be such a big part of the business, they've sort of willingly slowed sales of their owned brands, why? Because those were pointed more toward the luxury items, [laughs] the really cool clothing. And with the drop of a hat, when all the lockdown started, they decided that we are going to go with more third-party accessories, swimwear, loungewear, all the stuff that we think will sell if things don't improve within a few months. And even though it was a pet project to grow these owned brands, because they're more profitable, the management team was able to make a tough decision really quickly. So, that's part of it too. And it's one of the strengths, even as we're talking, Emily, just talking through this investment, that I'm finding, it's dawning on me that I like is, when you have two founders who are still very involved in the business after 17 years, and they work well together, they can take those tough decisions, they look out several years in advance for what will work and not afraid to do what it takes to protect the value of the brand and to protect the company from a financial standpoint. So, definitely kudos for that.

Flippen: It's funny, the Co-CEO thing still kind of blows my mind. The Michael and Michael situation; I'm going to call it that from now on. [laughs] The Michael and Michael situation at this company. Historically, if you look at the performance of companies that have had Co-CEOs, not the best track record. It's usually pretty hard to share power and control that way in an organization, but there are examples of companies that do it really well. And one that comes to mind is Atlassian, an Australian based software company that has successfully had two Co-Founder CEOs. Now, granted they're both not named Michael, so that's the unknown variable here right now. [laughs] I'm joking. But these are two Co-Founders that are equally involved in the company, maybe Revolve, like Atlassian, is the exception to the rule in terms of sharing power. Either way, I will carefully watch Michael and Michael, they'd be under my radar if I was invested in this company.

But looking forward at Revolve as a business, what do you think are the key points to watch? I'm watching Michael and Michael, what are you watching?

Sharma: I'm watching them as well. I'm also looking at their merchandising strategy as they go forward. So, the company did really well to make a shift to evergreen categories that are going to supply sales throughout the year and which are less reliant on festivals and events. This is a temporary shift that they're thinking about making a little more permanent, that in a post-COVID world, who knows, will we have another pandemic, will there be some other [laughs] disruptive event? And there's a good margin in selling accessories, beauty products year-round, so they're focused on those two categories. I mentioned you basically accessories and beauty, but they're also upping the denim sales, which is always an evergreen category, we all need denim, we all need jeans. And I want to just point out that their beauty sales increased 100% year-over-year in the third quarter for the second straight quarter, so that's obviously something that they are paying attention to, and I am too. I'd love to see more of a focus on that. I think beauty is a great category, we've got superstar companies over the years like Ulta Beauty which have profited in this space, and why not for these online e-tailers, they should get into this evergreen category as well.

I also, sort of, like that they're still going to push more lifestyle content, but it's becoming more than just about going to festivals and having fun. During COVID they rolled out this conference called Revolve You, [laughs] and this was an event that -- OK, let's be honest, it's infused with influencer culture. So, these categories I'm going to read out maybe you could be a little snarky about, but these were the topics of Revolve You, this multi-day conference that was totally virtual.

The business of social media, building a brand, career journeys, mental and physical health, and entrepreneurship. I actually sort of like this, because they're going for a deeper engagement with their customers, and saying that, hey, this whole social influencer business is more than just a way to make money, it's part of your lifestyle, it's part of your brand, but it could be part of your business as well. And we're part-and-parcel of that, whether you're a purchaser or you want to be an entrepreneur. I think it's a good step for them over the long-term.

And they're also still pushing their influencer creds, now they're trying to make sure that they are on the up-and-up with the latest TikTok fashion influencers. [laughs] Yeah, so those are my qualitative thoughts about them looking forward.

And yeah, I guess we should also talk a little bit about the stock price. I don't know if we really traced the trajectory, but just briefly, and I'd love your thoughts on this, when the company went public, it priced at $18/share. And I think on the first day, it soared to $34 and peaked at $47/share later in the month of June 2019. And after that frothy start, Emily, it came back down to earth [laughs] into the $20 several months later, just in time for the pandemic. The stock was as low as $7.30 in March of this year, it's really clawed its way out of that, it's back up into the $20s, but it's trading at around 33X forward earnings.

Do you have any thoughts on everything we've talked about in relation to maybe what that, sort of, spot valuation looks like?

Flippen: I do. And it's actually less about the valuation of Revolve and more about the stock price itself. I mean, I actually think 33X earnings for a company like this, while I am going to get a lot of flak for saying this is a profitable company, a lot of its competitors are not profitable, there is no earnings to compare it to, so that alone makes it more compelling. And 33X for a company that's growing this quickly, with such long tailwinds, to me, doesn't feel ridiculous. It depends on how much you trust Michael and Michael, but the more I say, Michael and Michael, [laughs] the more I want to give them my money ...

Sharma: The more I like it. [laughs]

Flippen: [laughs] The thing that confuses me, though, is, when I look at Revolve stock price, I'll just use the year-to-date, it's pretty much flat year-to-date. I think it's up, like, 15%, and that changes on the daily, so not a huge mover for 2020 so far. Compare that to Farfetch, which is up almost 400% just since the beginning of this year, that's year-to-date, what is it that makes Farfetch a nearly $20 billion business that is just commanding such appreciation from the market, whereas Revolve, doing a very similar thing with their really unique aspect is only about $1.5 billion and stock price has really languished. I mean, is this just a business that is losing out ground to competitors or is there something special here?

Sharma: I think there's something special. And I'm so glad you brought up Atlassian, let's stay on that theme, because Atlassian is a great example. I remember when the Software-as-a-Service explosion happened, as you will do. And over time, I think Atlassian represents, sort of, a fun place to put money and the stock has done really well, it's drawn a lot of attention, but that doesn't mean there aren't really other solid plays in the space. The same way here, Farfetch takes up a lot of oxygen and other specialty retailers have attracted a lot of money into the space. One of your favorites, and mine too now, it's growing on me so much, is Chewy, right?

Flippen: Oh, yay! [laughs]

Sharma: Chewy is an online specialty retailer, [laughs] I was skeptical about it, but I've listened to you talk about it, and I think I'm converted now. That draws so much attention. And then you've got a choice between some really big names, and then a lot of other companies, some of which are on different trajectories in terms of sales growth. And I think that's just what it is. And over time, I believe that this company can accelerate its sales again in a post-COVID world and it will draw some more attention. To me that's most of it.

And the other skepticism in the market probably just is the variability of that model that was exposed [laughs] during COVID, that you're relying on, in a lot of cases, teenagers to go to festivals to draw your audience and make sales. I think they're treating that though. [laughs]

Flippen: Definitely. Well, I'm looking forward to keeping my eye on this one in the future out. I'll quickly put out, it's not a warning so much as it is an FYI for investors. You know, a lot of our listeners are frequent consumer goods investors and they are used to this fourth quarter bump that exists with retail stocks, especially ones that sell clothing, that really doesn't exist for a company like Revolve, they make it very clear that the person who is purchasing on Revolve is doing so, for the most part, for themselves. They actually see pickups in the second quarter, whenever they have their festivals for the Summer, when they do a lot of their advertising. So, don't buy this company with the expectation that lots of people will send clothes in the fourth quarter for holiday gifts, there's no seasonality here the way there is with other businesses. Again, that plays into the uniqueness, but I did feel the need to get that out there before you finished up, just to not confuse any of our listeners.

Sharma: Absolutely. Such a great point.

Flippen: And with that, Asit, I know we're out of time. I just want to say thank you so much again for joining me, it's a pleasure to have you on every time, and you bring such fun, good knowledge.

Sharma: Well, thank you so much, Emily, I really enjoy it as well. And that this one too was so much fun, really exciting to talk about fashion. [laughs] For both of us fashion mavens, right?

Flippen: [laughs] I learned a lot.

Sharma: [laughs] Same here.

Flippen: [laughs] Well, listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out to say, "Hi!" you can always shoot us an email at [email protected] or tweet at us @MFIndustryFocus.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen, thanks for listening and Fool on!