The RealReal: Turnaround Plan Deserves A Vote Of Confidence (NASDAQ:REAL)

One of the best, tried and true ways to beat the market amid heightened volatility: pick individual SMid-cap stocks that have low correlation to the broader markets.

This is a risk-taker’s game, of course, but it has quite the potential to yield fruit. In the case of The RealReal (NASDAQ:REAL), the luxury clothing consignment platform, the struggling company has jumped nearly 3x this year on hopes for its turnaround plan.

I’ll cut to the chase here: I’m initiating The RealReal stock at a buy. In my view, the company has a number of levers under its belt to continue impressing the market and convincing investors that there is a path back to growth.

The RealReal stands out in a crowded field, especially as it shifts its focus on consignment

To put some background context behind The RealReal’s recent volatility: the e-commerce segment is in dire straits, especially the luxury sub-segment. Overhanging macro constraints are certainly among the biggest culprits for the industry’s challenges, including and especially difficulties in China (where high unemployment and falling real estate prices have wiped the “wealth effect” away for the world’s largest consumer market for luxury goods). Some companies are already on their last legs: Farfetch, a similar luxury e-commerce platform, has slashed a substantial chunk of its headcount and has been de-listed as a stock.

And yet, The RealReal isn’t quite in the same boat. Farfetch was weighed down by its physical retail arm, Browns- whereas the RealReal is an e-commerce platform only. Farfetch had plenty of exposure to struggling international markets like China, whereas The RealReal is primarily domestic.

And in my view, The RealReal is smartly initiating a turnaround plan that is preceding incoming woes, rather than reacting too late to them. It has a two-pronged approach to recovery:

• Renewed focus on consignment. The company is ditching its direct-sales business and dramatically shrinking down its inventory levels. Though overall GMV is down y/y, consignment sales are up. In addition, the revenue mix shift toward consignment and away from direct sales has pushed The RealReal’s gross margin profile above 70%.
• Debt restructuring. The company has also recently renewed all of its credit agreements. The company’s convertible debt notes are now not due until 2029, giving the company plenty of breathing room from a liquidity standpoint.

Of course, just because The RealReal is getting back to standing on its own two feet doesn’t mean that it’s without risk. The RealReal certainly isn’t the only clothing exchange marketplace out there – and yet, it does distinguish itself as being the leader in the luxury space.

Outside of Amazon (AMZN), eBay (EBAY), Etsy (ETSY) and other general resale markets, the one key competitor that stands to mind is Poshmark, a private company that also helps facilitate easy sales of used clothes. We do note the risk, however, that The RealReal has generally higher fees than Poshmark. Commission rates vary by the seller’s sales volume as well as category, but note that for somebody with between $1,500-$4,999 in annual sales, the seller keeps 71% of the sale price on clothing sales (this drops to 70% for someone with less than $1,499 in sales volume). Poshmark, meanwhile, takes a standard 20% cut (seller keeps 80%) across the board, regardless of sales volume.

The RealReal’s fee scheme changes, however, with different categories. Watches and sneakers, for example, carry a lighter 14% fee – and so for certain products, The RealReal is the more lucrative platform. And because The RealReal curates its selection more rigidly (it has a list of approved designers that sellers can list products from, whereas most competing platforms do not), it arguably has a better reach in the high-end marketplace than its competitors do.

All in all, I believe there’s plenty of salvage value in The RealReal that hasn’t yet been realized. Take the next dip as an opportunity to buy.

Encouraging flip to profitability

The RealReal’s stock popped in February alongside the company’s Q4 earnings release, which also included its FY24 outlook. The company was able to showcase the benefit of flipping to a primarily-consignment model, which lifted margins and overall profitability.

Overall, GMV is still down: in the Q4 holiday period, GMV of $450.7 million declined -9% y/y. And yet, consignment revenue of $113.5 million grew 2% y/y. Take rates, meanwhile, improved 200bps to 37.7%, alongside a large jump in average order value: +10% y/y to $545.

The RealReal is refocusing its story to be about gross profit growth, rather than GMV or revenue growth, especially as it ditches its direct-sales arm. Despite the overall GMV decline, gross profit dollars grew 10% y/y to $106 million, which represented a 74% gross margin (versus 60% in the year-ago Q4).

Meanwhile, adjusted EBITDA flipped to a $1.4 million profit: at a 1.0% margin, an improvement of fourteen points y/y:

The company’s outlook calls for breakeven adjusted EBITDA in FY24 at the midpoint, alongside revenue of $580-$605 million: which represents a 10-11% y/y revenue growth range:

We note as well that the company launched drop ship capabilities in Q1, which is expected to be a new (yet small at the outset) revenue stream for the company.

Valuation and key takeaways

At current share prices near $4, The RealReal trades at a market cap of $397.8 million. After we net off the $175.7 million of cash and $104.8 million of convertible debt on The RealReal’s most recent balance sheet, the company’s resulting enterprise value is $326.9 million.

Of course, near-term valuation multiples are going to be less indicative for The RealReal as it undergoes its business model transition and focuses on profitability. However, we can do multi-year projections. In FY24, the company’s -1% to +1% adjusted EBITDA margin, at the 0% midpoint, represents a 10-point margin improvement to FY23. If we assume in FY25 that the company sees half of that y/y margin improvement (to a 5% adjusted EBITDA margin) on consensus FY25 revenue estimates of $647 million (+10% y/y), we’d get FY25 adjusted EBITDA of $32.35 million. Using these assumptions would give us a valuation of 10x EV/FY25 estimated adjusted EBITDA.

As discussed throughout this article, there are a number of catalysts for both the upside (tertiary revenue opportunities including drop ship, growth in consignment revenue and large gross margin gains, macro rebounds) as well as to the downside (more aggressive price competition from similar platforms, continued softness in consumer luxury spending). The next catalyst for the stock will be its Q1 earnings release, due in early May.

Given the large leaps in profitability and relatively low market cap, however, I’m willing to take a small bet on this company.