RealReal stock: too much risk (NASDAQ:REAL)

Investment thesis

The Real Real (NASDAQ: REAL) is an American high-end resale commerce company founded by Julie Wainwright in 2011. Unlike most e-commerce companies, RealReal operates as an online marketplace only for authenticated and resold luxury goods. It’s not sourcing from brands rather than receiving supplies from shippers, it then authenticates and lists these items online. When an item is sold, RealReal charges a commission on the sale price. The company provides an end-to-end service to shippers and aims to bundle and organize unique and pre-owned luxury items.

The company has seen a huge surge in the stock price due to the pandemic accelerating online trade sales and the cash the Fed injected into the economy, such as stimulus checks. Its stock price rose from $6.4 in March 2020 to over $28 in February 2021, up more than 400% in one year. However, as the rate of inflation began to rise, combined with the massive sale of speculative stocks in the market, the company’s share price fell more than 90% from its all-time high, now trading at $2.77.

Despite the huge drop in share price, I think RealReal is still selling. It has a great TAM and shows decent growth, but profitability remains a major concern. The business has little moat and the competition becomes very fierce as new entrants enter the market. The uncertainty within the macroeconomic environment and the weakening economy will also cause significant headwinds on RealReal as it is a consumer-oriented business.

Market opportunity

RealReal has a huge TAM (Total Addressable Market). The online luxury goods market has grown rapidly due to the expanding economy, mainly attributed to the QE (quantitative easing) implemented by the Fed over the past decade. According to Farfetch, the global personal luxury goods market is expected to grow from $322 billion in 2019 to $437 billion in 2025, representing a CAGR (compound annual growth rate) of 5%. While the e-commerce market share for sales of personal luxury products is expected to increase from 10% to 25% in 2025, i.e. 2.5 times greater growth over the period.

Although a resale business, the RealReal benefits from the growing market for first-hand personal luxury goods, as it allows them to have more new supplies of goods to sell. According to The RealReal, there are currently $196 billion in luxury goods available for resale, with $37 billion in new supply each year. The shift to used items is accelerating due to the latest trend in sustainability and ESG. However, whether the trend can last remains the biggest question.

fierce competition

While the TAM for The RealReal is huge, it also faces some very stiff competition. The luxury market is a zero-sum market. Consumer spending is essentially fixed and it is up to companies to try to capture as much market share as possible. Therefore, The RealReal not only competes with other resale companies, but also with other luxury e-commerce companies like Farfetch (FTCH) and traditional luxury brands like LVMH (OTCPK: LVMHF). In the resale market, the company faces competition from Vestiaire Collective, Grailed, eBay (EBAY) and Depop, which is owned by Etsy (ETSY).

Vestiaire Collective operates with an almost identical business model, while Grailed, eBay and Depop are resale marketplaces that also focus on categories other than luxury goods. The barrier to entry into this market is relatively low, which is why companies like Farfetch are entering the space, aiming to become both a premium and pre-owned luxury goods market space. He also has an advantage because he already has a large following. I think there will be more companies entering in the future, which will further increase the competition in the future. RealReal is currently the market leader in second-hand luxury goods, but it will need to develop a strong moat to consolidate its position.

Strong macro headwinds

The current uncertainty regarding the macro environment will likely show significant headwinds on The RealReal. The inflation rate remains at high levels and the supply chain lockdown continues. This has led to a decline in consumer purchasing power, which weakens the economy. We are already seeing a significant downturn in the economy across the board, with companies like Target (TGT) lowering their forecasts, Snap (SNAP) issuing uncertainty warnings, Tesla (TSLA) laying off employees, and more.

Julie Wainwright, founder, on inflation

The near-term risk to the business continued to be inflationary pressures on our transportation costs and attracting and retaining commercial and operational talent. For transportation costs, we are taking immediate action to offset these increases. For sales and operational recruiting, we ended the quarter in good shape. However, we are actively recruiting to fill positions as we grow.

RealReal is highly exposed to these headwinds because it is a consumer-oriented company. As purchasing power weakens, consumers now have to spend more on essentials, reducing discretionary spending. According Michigan Consumer Sentiment Data, consumer confidence has plummeted and is now at levels seen since the Great Financial Crisis. I think discretionary spending will continue to decline, which will hurt The RealReal a lot as it is primarily focused on the high-end market. High fuel prices will also increase the company’s logistics costs and further weaken its bottom line.

Profitability remains an issue

The real real announced its first quarter results in May. It posted revenue of $146.7 million, up 48% year-over-year (YOY) from $98.9 million. Consignment and service revenue accounted for $97.9 million, while direct revenue accounted for $48.8 million. Gross profit increased 34.8% from $58.3 million to $78.6 million. GMV (gross merchandising volume) was $428 million from $327 million, an increase of 31%. It ended the quarter with 828,000 TTM active buyers, up 21% year-on-year from 687,000. Average order value rose 3% to $487. The company forecasts FY22 revenue of $635 million to $665 million, with negative Adjusted EBITDA of $(100) to ($80) million. However, I believe the company’s growth rate will start to slow down due to the macroeconomic turmoil mentioned above.

Despite decent turnover, profitability remains low. The operating loss went from less than ($52.8) million to less than ($54.7) million. While the Adjusted EBITDA loss improved slightly from ($35.6) million to ($35.3) million. The loss is largely attributed to higher cost of revenue, which rose 68.1% year-over-year from $40.5 million to $78.6 million. This is due to the increase in logistics costs as the price of fuel remains at a very high level. Operating cash flow was negative at ($49.3) million versus ($47.8) million. Net loss per share was $(0.61) compared to $(0.62) a year ago. It should be noted that the number of weighted average shares has increased from 90 million to 93.5 million. This is a trend worth noting, as continued dilution is very detrimental to shareholders. The company’s balance sheet is also quite fragile, with $605 million in debt and only $361 million in cash. This will be a problem as the company is still showing a loss and negative cash flow.

Conclusion

In conclusion, I think The RealReal is operating in a very difficult situation. Despite having a large addressable market, the company faces increasing competition not only from resale companies, but also from other luxury e-commerce companies. The barrier to entry into this market is quite low, therefore, there will only be more and more competitors in the future. It faces strong headwinds from the macro environment. Rising fuel costs are already weighing heavily on the company’s results. As the economy continues to weaken and consumer confidence falls, discretionary spending is likely to contract rapidly. The company is showing decent growth, but profitability remains a concern. It still shows negative earnings and cash flow while having a net debt of $244 million. The number of shares in the company also increases, which dilutes the shareholders. Therefore, I believe The RealReal is a sell at the current price.