For a Luxury Fashion Bargain, Buy Secondhand With RealReal

San Francisco-based The

RealReal

REAL 2.23%

has 19 stores across the U.S. where people can bring their used handbags, watches, clothes and jewelry to consign for sale online, as well as a 450-strong sales team that goes to people’s homes to collect their unwanted designer goods. The items are then authenticated, photographed, priced and listed for sale online. In return for taking the legwork out of selling, The

RealReal

takes a 36% cut of the transaction price on average.

Since its initial public offering in 2019, The RealReal’s stock is down around 90%. The business is expensive to run and has never made a profit. At an investor day earlier this year, the company pledged to generate at least $100 million in adjusted earnings before interest, taxes, depreciation and amortization in 2025.

The RealReal’s bottom line should improve if sales settle back into their old pattern. During the pandemic, the company had to buy inventory outright rather than take in consignments, as home visits became difficult during lockdowns. These low-margin own-inventory sales jumped from around 15% to 20% of the business in 2019 to 28% today. This number should fall in the third and fourth quarters of this year. The midpoint of The RealReal’s full-year guidance implies an adjusted Ebitda margin of minus 7.5% in the fourth quarter, an improvement from minus 18.7% in the second quarter.

Technology may reduce labor costs. The RealReal hires hundreds of expert authenticators to weed out fakes, which is expensive but essential if it is to maintain shoppers’ trust. By the end of this year, 40% of handbags will be authenticated using machine learning.

The problem with the stock is that no one really knows how an online luxury reseller will perform in an economic downturn—The RealReal was only founded in 2011. To hit its 2025 profit goal, the company needs to be selling roughly $5 billion of goods a year by then, up from the roughly $1.9 billion it expects in 2022.

So far, growth still looks healthy. The company’s gross merchandise value increased 30% in the three months through June compared with a year earlier. Strong U.S. demand reported by high-end brands such as

Hermès

and Louis Vuitton in recent weeks shows that luxury spending is resilient for now, even as the wider economy weakens.

Secondhand luxury websites could benefit as designer labels push through big price increases in the primary market. Brands including Chanel,

Christian Dior

and Gucci have increased prices of their most popular handbags by 10% on average so far this year, on top of an 11% increase in 2021, based on Jefferies analysis. This may encourage some shoppers to trade down to used goods where prices are typically 30% to 40% cheaper than buying new, according to Morningstar.

In the longer term, the secondhand clothing market is expected to grow as consumers become more aware of the environmental impact of the fashion industry. Mass market brands such as Patagonia,

H&M

and

Lululemon

already accept used goods in return for store credit, but their terms are poor. Shoppers that bring back goods to Levi’s will take a haircut of around 75% on what they originally paid, Morningstar analyst Sean Dunlop notes. That makes The RealReal’s commission of roughly one-third relatively appealing. Luxury goods’ high prices make them especially suited for resale.

The RealReal’s stock currently trades at just 0.4 times projected sales, down from six times in more bullish years. For investors willing to tolerate some flaws, fashion trends should eventually move in the company’s favor.