Revolve Group: Potential for margin expansion with decent risk-reward (NYSE: RVLV)

Revolution Group (NYSE:RVLV) is an e-commerce fashion company targeting high-end Gen Z and millennial consumers.

Historical stock market performance has been poor. RVLV went public in 2019 at a price of $34 per share, but is currently trading at $22 per share, down 35% on a historical basis. RVLV hit its all-time high of $86 per share in 2021, driven by e-commerce trends in the COVID era. However, the price continued its downward trend into the mid-teens until recently. Over the past year, RVLV has gained momentum, with the stock price appreciating nearly 28%. This was also driven by the strong year-to-date performance, where RVLV has seen an increase of over 32% in its stock price so far.

I consider RVLV a Buy. My one-year price target of $23.6 per share projects an upside of about 7%. However, I made conservative assumptions, since I did not cook in the share buybacks and also lowered the bullish revenue estimate for the fiscal year. More importantly, RVLV is also expected to continue to see its margins increase, thanks to changes in return and exchange policies. Ultimately, I think RVLV is still an e-commerce company with decent financial strength that is overall well-positioned for a rebound.

Financial reviews

The fundamentals have been rather disappointing lately. Activity has seen an overall decline since last financial year due to macroeconomic challenges. In the first quarter, RVLV did not achieve its objectives by achieving a turnover of 270.6 million dollars, already a drop of more than -3% year-on-year. At the same time, the profit margin has seen a slight contraction, falling from more than 10% in 2022 to less than 5% recently. In the first quarter, RVLV’s net margin was just over 4%, but it was already a significant improvement from 1% in the previous quarter. A positive aspect of RVLV is its ability to generate positive operating cash flow (OCF). In the first quarter, RVLV generated over $38 million in OCF, further increasing liquidity, which has remained relatively stable given the turnover volatility of late. RVLV ended the first quarter with over $273 million in cash and short-term investments.

Catalyst

While I believe the catalyst for growth remains minimal, RVLV appears to have made strategic changes to continue to drive margin expansion. In my opinion, given the continued challenging macroeconomic environment that may continue to exert downward pressure on the luxury sector, RVLV’s recent move to improve profitability and generate OCF is sensible enough.

Areas where I believe RVLV will continue to see further improvement in fiscal 2024 would be execution, sales and distribution (S&D). The two items combined accounted for more than 20% of revenue in the first quarter, suggesting that these are significant cost items. As such, the improvements here will be enough to drive margin expansion forward. In my opinion, these improvements will be driven by the recent change in return policies, as management commented in Q1:

And finally, starting last week, we reduced our product return window to 30 days for returns and 60 days for exchanges, in line with the returns and exchange window we had successfully offered for many years before the pandemic. You may remember that in March 2020, after the pandemic began, we increased the return and exchange window to 60 days and 90 days, respectively.

Source: First quarter earnings call.

I think shorter return and exchange windows could potentially reduce the number of returns and also attract customers with higher lifetime value profiles. Indeed, they will also help reduce execution and S&D costs, thereby increasing margins. The recent change is also unlikely to have a significant negative impact on customer experience. According to management’s Q1 commentary, there appears to be ample room for RVLV to make these adjustments, given its continued strong reputation for returns friendliness:

Our analysis of the competitive landscape confirms that our hassle-free returns policy remains among the friendliest in the industry, especially since most clothing retailers now charge their customers a fee for online product returns. In comparison, we continue to encourage our customers to use the home as a dressing room with a hassle-free and free delivery and returns policy, which we have offered since our launch in 2003, making us one of the pioneers in returns free.

Source: Q1 earnings call.

Risk

Despite the potential for margin expansion on paper, management also suggested that the extent of the impact of yield policy changes on the rate of return still remains unclear through commentary during the call for investors. results :

Yeah. That’s a pretty significant portion of returns that happen outside of the 30 days. This is a minority, but it represents a significant share and this share has increased over time. So I love seeing what kind of impact the return policy has. We certainly hope that there might be some level of impact, but I think it’s one of those things where you know you definitely can’t know for sure if there’s going to be a positive impact or not until you deploy it. We will therefore have to see what type of impact this has on the overall return rate.

Source: Q1 earnings call.

On the other hand, given that the share of returns outside of 30 days has been quite considerable and has also increased over time, I think there is a risk that RVLV will experience a slowdown in orders or that customers will reduce potentially the number of orders per transaction. This could potentially be a drag on revenue growth. In the first quarter, for example, orders placed were already trending downward on a QoQ basis despite the steady increase in the number of active customers.

Valuation / Pricing

My price target for RVLV is determined by the following assumptions for the bull or bear scenarios of the FY 2024 projection:

1. Bullish scenario assumptions (50% probability): I expect revenue to increase 2.9% year-over-year to $1.1 billion, or $40 million less than the high-end market estimate. I assume the forward P/S will increase up to 1.8x, implying stock price appreciation to a $27 price level, driven by positive market reaction as RVLV has returned to positive annual revenue growth.

2. Downside Scenario Assumptions (50% probability): RVLV is expected to generate revenue of $1.07 billion for fiscal 2024, representing almost flat annual growth. I would expect the P/S to remain at the 1.3x level, leading to a correction in the stock price to $19.5.

Consolidating all of the above information into my model, I arrived at a weighted fiscal 2024 target price of $23.6 per share, a projected one-year upside of approximately 7%. I would rate the stock as a Buy.

My 50-50 bull-bear probability assignment is based on my belief that RVLV’s overall performance for the fiscal year remains uncertain, particularly given the relatively large distance between market revenue estimates under the bear and bear scenarios. bulls. However, it is also important to note that my projection remains conservative. For example, I did not incorporate share repurchase activities into my price target model. Additionally, I also reduced the revenue estimate by $40 million. Given this, I think RVLV could potentially see an upside greater than 7%. RVLV still has decent fundamentals and is, in my opinion, well-positioned to see accelerated growth beyond FY2024.

Conclusion

RVLV is a fashion e-commerce company targeting Gen Z and millennials that has recently experienced a slowdown in revenue growth. The growth potential for fiscal 2024 remains, in my opinion, uncertain. However, the margin could potentially experience further expansion, driven by strategies to optimize return and exchange policies. RVLV has decent liquidity and ability to generate OCF, positioning it well for a rebound beyond fiscal 2024. My price target calls for a 7% upside, but it’s possible that the stock also achieves higher upside, given conservative assumptions. I rate the stock as a Buy.