Stitch Fix: Back To Growth Mode

Summary

• Stitch Fix missed FQ3 estimates due to the virus shutting down the majority of their distribution centers.
• The online personalized stylist service predicts a return to growth in the current quarter.
• The stock trades at an absurd 1.1 EV/S despite normalized revenue growth in the 20% range.
• This idea was discussed in more depth with members of my private investing community, DIY Value Investing. Get started today »

Like most companies in the retail sector, Stitch Fix (NASDAQ:SFIX) saw weakness during the most recent quarter. The online apparel personalization service had the fortunate benefit of offering online sales without the need for retail locations, but the company had to close distribution centers during the virus outbreak. My investment thesis remains highly bullish on the stock looking for some cooling off after the 100% bounce off the $11 lows.

Image Source: Stitch Fix website

Bad Quarter, But Not Horrible

While most apparel retailers saw a substantial hit in the quarter covering the coronavirus shutdown, Stitch Fix only saw revenues dip 9.1%. For FQ3, revenues were only $371.7 million versus analyst estimates up at $414.5 million.

The company is predicting that without closing fulfillment centers, sales would've grown YoY due to a large backlog of orders. In fact, the company is back to full warehouse capacity now, but Stitch Fix doesn't forecast eliminating the order backlog until the end of June in a sign of strong demand despite slow deliveries.

At the end of March, Stitch Fix initially closed facilities in San Francisco, Dallas and Bethlehem, PA, leaving over half the fulfillment facilities closed with capacity dropping 70% by the end of the month. Even after reopening facilities, the company allowed warehouse workers to opt-in to return to work, reducing the workers far below full capacity.

Even with the coronavirus issues, the company saw active clients grow 9% in the quarter, but the amount was down from the previous quarter. Investors should expect Stitch Fix to see clients jump in the current quarter. A return to 10% client growth similar to last year would lead to record client counts of 3.65 million for the current quarter.

Source: Stitch Fix FQ3'20 shareholder letter

A big part of the sales weakness was due to the distribution center issue where up to 70% of capacity was closed at the peak of the pandemic. The other issue was the wise decision to cut marketing expenses based on the lack of fulfillment capacity.

Stitch Fix only spent $37.8 million on advertising in the quarter, down 25.1% from last year. The company had planned to spend an additional $17 million in order to boost advertising by ~10% in the quarter from the $50.4 million spent last FQ3.

The company is in a strong position to boost active clients and sales going forward as some consumers remain concerned about shopping in stores while the remaining customer base returns back to normal spending habits. In addition, Stitch Fix plans to cut personalized stylists in California and move up to 2,000 new positions to lower cost cities such as Austin where the company will create stylist hubs.

Stitch Fix has high SG&A costs with solid gross margins of ~45% in normalized quarters. The company forecasts the shift outside of California will lower costs, but the company didn't provide any indication of the financial benefit of moving part-time stylists to new locations.

In prior quarters, SG&A amounted to over 40% of revenues. The company had originally forecasted adjusted EBITDA of ~$80 million, so any ability to generate higher EBITDA by lowering costs would reward shareholders.

Deep Value

The real question with Stitch Fix is how to value an apparel retailer with consistent growth in the 20% range. The market generally values the company like a slow growth option at ~1.1x EV/S.

Data by YCharts

Retail brands such as Lululemon Athletica (LULU) and Nike (NKE) with similar gross margins and profit pictures trade at much higher EV/S multiples. Even Nike with only 7% growth and the same gross margins trades at triple the EV/S multiple of Stitch Fix. In reality, Stitch Fix is a mixture of the growth of Lululemon and the margins of Nike.

Data by YCharts

My ultimate view is that the company eventually gets valued more like a retail platform with AI and big data driving solid growth from premium services to warrant a higher multiple. Comparing the company to retail brands like Nike isn't completely accurate, but Stitch Fix has similar financials with adjusted EBITDA margins approaching 5%.

The company is constantly innovating such as the Direct Buy option and moving into new categories including exclusive offerings.

Takeaway

The key investor takeaway is that Stitch Fix successfully navigated the difficult period in the apparel retail sector. The company is now positioned for a return to growth while the stock still trades at deep value. The stock only trades at 1.1x EV/S while retailers with similar margins and growth profiles trade at far higher multiples.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SFIX over 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Comments

[Atwood9]

Dead money why would you invest in the apparel sector right now. Macy’s Nordstrom...long list of stores that will be heavily discounting the balance of 2020.

[Stone Fox Capital]

@Atwood9
Why would they be discounting Summer/Fall/Winter Clothes?

[sarge101abn]

Wow 46.6% short interest, I wonder if these folks are as correct as they have been so far in this market😆

[Shinde Investment Ideas]

What caused the gross margin to drop? Distribution center closure would drive sg&a up but shouldn't have impacted gross margin

[Nitin B. Sharma]

@ShinMeister

From their earnings call transcript:

"Q3 gross margin was 40.8%, 430 basis points lower than Q3 of last year. This is largely driven by COVID as we increased our inventory reserve as well as higher clearance rate due to the topline softness. Partially offsetting was continued favorability and merge costs."

seekingalpha.com/...

[Shinde Investment Ideas]

Thanks both items one does not want to see for a company with strong growth and customer appeal prospects, however covid19 impacts are tough for any business to take on. Lets see how they do in next quarter. I am long sfix

[Stone Fox Capital]

@ShinMeister
One really has to throw out some numbers during a pandemic.

@Nitin B. Sharma
Thanks for posting the info from the call.

[Blevinati]

I think we retrace these gains on SFIX down into the high teens before running again up to $30

[EliasMouawad]

@Blevinati Very probable if there is a market correction.

[Atwood9]

Deep value? 1/2 their quarter was before corona hit the current quarter will be more of the same.

[Boaz1]

it is almost at the pps of pre covid. Do you say it's in a better position today?

[Ashay Kadu]

Do you have any thoughts on their total addressable market and how likely are more people to shift to personalised shopping, given its expensive for a common man?