Cutting Our Revolve Fair Value Estimate on Weak Near-Term Prospects; Shares Still Cheap

Revolve reported mixed third-quarter results despite its $268.7 million in revenue and $0.16 in diluted EPS surpassing our $260 million and $0.12 estimates. While customer growth was encouraging, up 34% annually, mere 3% sales growth in October suggests vulnerability to a weak economic environment and has led us to re-evaluate our assessment of the firm’s business cycle sensitivity. It has become apparent that no-moat Revolve performs more like a mass apparel retailer than a luxury brand, with a sharp third-quarter deceleration in sales momentum and deteriorating profitability attesting to its cyclicality. We raised our Morningstar Uncertainty Rating to Very High from High earlier in the year and are now raising our cost of equity to 11% from 9% to reflect our change of view and lukewarm guidance; this should drive about a 20% contraction in our $46 fair value estimate. We still view the shares as undervalued, trading at about a 40% discount to our revised intrinsic valuation, but we don't expect sales growth to reaccelerate or meaningful margin leverage until macro pressures abate.