Stitch Fix - An Opportunity Of A Lifetime

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About: Stitch Fix, Inc. (SFIX), Includes: AAP, AMZN, ETSY, FTCH, GPC, GPS, JWN, WMT
by: Crispus Nyaga
Summary

Stitch Fix stock has declined sharply as investors worry about competition.

I explain why Amazon's Personal Shopper is not a major threat to SFIX.

I also explain why Stitch Fix does not need to go mainstream to succeed.

Image result for beyond yoga stitch fix

I wrote about Stitch Fix (SFIX) in May, when I hailed the company as the start of something new. Since then, the stock has declined by 20% even after the company reported excellent results and raised its guidance in June. There are two main reasons for the current weakness in the company’s stock. First, investors are worried that the industry is getting crowded especially after the recent entry by Amazon (AMZN), Banana Republic (GPS), and Nordstrom (JWN). Second, investors are worried about the recent tariffs, which will rise prices of apparel. Indeed, the S&P 400 apparel retail index has declined by 20% while the S&P 500 has risen by 18%. In this article, I will explain why the current weakness is a perfect buying opportunity for the stock.

To starters, Stitch Fix is a company that aims to disrupt the massive apparel industry. The company was started in 2011 and went public in 2017. As a public company, the company’s value has risen by 28% and is currently valued at more than $1.95 billion. At its peak, the company was valued at more than $5 billion. In 2016, the company has total revenue of more than $730 million. This rose to more than $1.2 billion in 2018 and investors expect the revenue to reach $1.5 billion this year and $1.9 billion and $2.29 billion in 2020 and 2021 respectively. Stitch Fix joined a rare club of startups that are generating a profit. In 2018, the company had a net profit of more than $44 million and an EPS of $0.47. In the most recent quarter, the company had a net income of $7 million.

Competition Not a Threat

In July this year, Amazon launched Personal Shopper, a product that is very similar to Stitch Fix. The service is now part of Amazon’s Prime Wardrobe that was launched 2 years ago. The company did this with the goal of expanding its apparel segment. At the time, Prime Wardrobe was said to be a Stitch Fix killer.

Amazon is not the only company competing with Stitch Fix. Nordstrom has its Trunk Club while GAP announced that it will launch Style Passport later this year. Le Tote, an earlier competitor recently acquired the iconic Lord & Taylor as it continues to build its brand. Walmart (WMT) seems to be headed in the same direction. In June this year, the company launched its own subscription product for kids called Kidbox. There are other small brands like Menlo Club, YogaClub, and Golden Tote among others.

From afar, investors seem to be right about worrying about the impact of competition on the company’s market share and margins. The new competitors have a well-known brand than SFIX. They also have more money, which can help them lure the best talent and undercut SFIX. However, a closer look at the company’s performance and brand recognition shows that investors should have nothing to worry about.

First, I submit that more shoppers will likely prefer Stitch Fix than a company like Amazon, Nordstrom, GAP, or Walmart. While Amazon and Walmart will always be the place where we buy electronics, toys, and books, I believe that apparel is unique. Shoppers who want a subscription box will prefer Stitch Fix, which is a pure play fashion company. The company has been in business for the past 8 years during which it has learnt a lot. They believe the company adds a personal touch to the shopping experience. This is the main reason why the company has continued to add the number of shoppers. In the most recent earnings call, the company had more than 3.1 million customers. This was a 17% year over year growth from the previous year. The company has seen this growth even with Amazon’s Prime Wardrobe and Nordstrom’s Trunk Club. As shown below, SFIX beats Trunk Club when you compare user statistics.

Source: Similar Web

In the past, investors have tended to overreact when Amazon enters in certain industries. A few years ago, the stock price of the newly-IPOed Etsy (ETSY) dropped sharply after the company launched Amazon Handmade. In 2017, the stock price of autopart dealers like Advanced Auto Parts (AAP) and Genuine Parts (GPC) declined sharply after Amazon entered into the business. All these companies have done just fine since Amazon entered the business.

Therefore, as a small and niche company, customers interested in fashion boxes will always prefer Stitch Fix than a big company like Amazon, which serves millions of people every day.

Growth Levers

Another concern that investors have on SFIX is that its growth is slowing. The active user growth dropped from 31% in 2017 to 17% in the most recent quarter. A Seeking Alpha article published after the earnings release raised concerns that the company will likely never go mainstream. However, this article misses the point. Stitch Fix does not need to go mainstream to become successful. It needs to establish itself as a strong brand, create a loyal user base, and then add more products.

The company is doing this through its three pillars of growth. These pillars are expanding relationships with existing customers, attracting new customers, and growing the market opportunities. The company is already working to achieve these goals. In 2018, the company expanded its products to Stitch Fix Kids, a product that is targeted towards kids. The company hopes that it will retain some of these young ones as they grow older, which is a great idea.

Before that, the company had launched Stitch Fix men. In 2018, the company expanded deeper into footwear. There are more opportunities within the apparel and beauty industry that the company can get into. For example, the company can expand deeper into athleisure, a trend that is growing in the United States, Canada, and Europe.

As a result of all this, the company has been increasing the average revenue per user. This is the number that investors should focus on. While the number of active users has been increasing, the average revenue per client too has been on an upward trend. This is incredible because you would expect the revenue per user not to increase as the number of users increase. In the recent earnings call, the company said that:

Net revenue per active client growth 8% year-over-year representing our fourth consecutive quarter of growth, even with the higher mix of Men's and Kid's clients. This growth is the result of our continued focus on attracting high quality clients, improving our personalization capabilities and driving stronger retention in our Women's category.

Valuation

Finally, I believe that the company is significantly undervalued. As of this writing, the company is valued at more than $1.95 billion. Based on the estimated revenue of $1.5 billion, the company has a forward PS ratio of 0.85, which is lower than the ETSY’s 6.13 and FarFetch’s (FTCH) 2.0. Analysts expect the company to generate an EBITDA of $41.6 million, $65 million, and $107 million in 2019, 2020, and 2021 respectively. As such, the company’s forward EV to EBITDA has dropped to 23.5, which is the lowest level it has been. Looking at the company’s multiple and comparing them to the continued growth shows that the company is relatively undervalued.

Conclusion

Stitch Fix stock has been on a downward trend. As explained in this article, I believe that the company will continue being a market leader in apparel subscription industry even with the massive competition from the likes of Amazon. Second, the company has multiple growth levers including international expansion and launching of new services. Third, investors focused on the company’s user growth are looking at the wrong metric. The company will continue doing well as a niche play. Finally, the company’s valuation is reasonable, which makes the current price an ideal entry point before the next earnings report in October.

Disclosure: I am/we are long SFIX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.