Stitch Fix: Strong Flywheel Effect In Fashion
Summary
- Stitch Fix has enjoyed steady customer growth and higher spending from its personalized styling platform.
- The company has been self-funding its reinvestment in growing into new markets and categories.
- Stitch Fix appears to be fairly cheap when compared to its previous sales multiples.
Stitch Fix (NASDAQ:SFIX) has steady revenue growth going into the year due to its strong platform and personalized recommendations for customers. The company's data engine has been powering a flywheel effect for its platform, with more customers leading to more data and better recommendations. Potential investors would have to pay a 1.38x price-to-sales multiple for the company, which appears to be fairly cheap compared to the highs of its trading range in the past year. Despite some risks navigating through the current uncertainty, Stitch Fix has been EBITDA positive since 2015 and maintains a strong financial position to withstand any revenue shocks.
Growth has been powered by data science and stylists
Stitch Fix has created long-term relationships with customers by helping them find and personalize apparel, shoes, and accessories. Its customers are motivated to share their personal details with the company, which provides a feedback loop to deliver more successful outcomes for the customers.
With this value proposition, Stitch Fix has grown its active clients from 2.9M to 3.4M year-on-year at a growth rate of 17%. Customers' spending on the platform has also increased over the same period from $463 per customer to $501, representing a growth rate of 8%. These metrics have led to a 22% growth in revenue year-on-year to $452M in Q2 2020.
(Source: Investor Presentation)
The engine that has been driving growth is Stitch Fix's data science. Most of the customers' data are provided directly by the customers through a style profile rather than inferred from their purchasing behavior. Customers also provide feedback after shipments that enhances the accuracy of the algorithm. Stitch Fix also collects extensive merchandise data like inseam, pocket shape, silhouette, and fit. This large data set allows the company to improve its personalization strengths, which helps increase the value proposition to its customers.
One of the future growth drivers will likely be driven by an increasing share of the customer's wallet. As customers begin to increase their trust of Stitch Fix's platform, they might shift more of their spending from self-selection of apparel and accessories to relying on the company. As Stitch Fix continues to improve its recommendation engine, new customers would also join its platform after hearing about the successful recommendations made for their peers. With a large apparel market at $505B in 2024 and online sales growing at a faster pace than the overall market, Stitch Fix has a long runway for growth to take a larger piece of the market.
(Source: Investor Presentation)
Stitch Fix is strengthening its flywheel through data science
With its large customer base, the data engine generates a feedback loop where purchases lead to more data and better recommendations. This creates a barrier of entry for smaller companies as their recommendation engine would likely not be as strong as Stitch Fix:
On average, each client directly provides us with over 90 meaningful data points through his or her style profile, including detailed style, size, fit, and price preferences, as well as unique inputs such as how often he or she dresses for certain occasions or which parts of his or her body the client likes to flaunt or cover up. Over time, through their feedback on Fixes they receive, clients share additional information about their preferences as well as detailed data about both the merchandise they keep and return. Historically, over 85% of our shipments have resulted in direct client feedback. This feedback loop drives important network effects, as our client-provided data informs not only our personalization capabilities for the specific client, but also helps us better serve other clients. (Source: Latest 10-K)
This advantage allows Stitch Fix to continue to increase its value proposition over long periods of time and gradually increase its revenue per customer.
Impact on long-term prospects
We expect an 18-22% compound annual growth rate over the next five years, driven largely by growth in users and increased spending. Given Stitch Fix's recent growth rates of over 25% and the launch of a new adaptive styling platform, we believe this growth is achievable.
Stitch Fix has generated positive EBITDA since 2015 and has been reinvesting back into its business and new category growth like its men's category. Its strategy has been to drive leverage across its existing offerings while using cash from those offerings to invest in newer categories. Over the years, the company has proven its ability to expand into new categories and geographies to drive growth. Hence, we expect that EBITDA margin will continue to be weak as the company continues to invest. The company guided 0-0.5% EBITDA margin for fiscal 2020, and we expect that to continue for the next five years as it prioritizes growth.
Investment Risks
Due to the recent uncertainty, Stitch Fix has withdrawn its guidance. This is mainly attributed to the constraints placed on its distribution centers and operations. As more people stay at home, the need for curated fashion pieces might drop in the short term as well. This means that there could be some headwinds for Stitch Fix's cash flows in the short term.
Stitch Fix also states its total addressable market as $505B, but the market appears to be much smaller than that. The company appeals more to customers that prefer personalization rather than those that just buy clothes for utility. The future growth of Stitch Fix depends on customers' preferences for personalized clothing and the company's ability to capture a large share of that market.
Balance sheet looks reasonable
Looking at its latest balance sheet, Stitch Fix has $165M of cash, and $134M of short-term investments, with no debt. Since Stitch Fix had positive free cash flow in the last fiscal year of $25.1M, this provides a large cushion to invest in growth. It also helps Stitch Fix tide through any operational difficulties in volatile periods. The company has a history of generating positive EBITDA since 2015, so it is unlikely that it would face a cash crunch in the short term.
(Source: Investor Letter)
Valuation
With the more than 100% run-up since April, Stitch Fix's price might appear to be overvalued to some. But based on its past year's trading range of 0.7 to 2.7 price-to-sales ratio, the current price-to-sales ratio of 1.38 appears to be a good price for investors looking to build up a position in this company.
(Source: Seeking Alpha)
Takeaway
Stitch Fix has built a personalization clothing brand with a strong data science recommendation engine that appeals to customers. The company has strong unit economics as seen from its positive cash flow generation since 2015. Despite risks from the current uncertainty and shopping trends, the company should be able to carve out a decent chunk of the market for itself due to powerful data-based flywheel effects.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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