Stitch Fix: The Worries Are Multiplying

Summary

• Stitch Fix, already down ~80% year to date, continues to hover around year-to-date lows on little hope for a turnaround.
• The company expects revenue declines to decelerate to -20% y/y in fiscal Q1.
• Losses are piling up as well, as Stitch Fix faces margin pressures and can't cut staff faster than its revenue declines.
• With liquidity also declining and capital markets tight, Stitch Fix may be in quite a difficult situation.

Liudmila Chernetska/iStock via Getty Images

For the most part, I view the current tech correction as a temporary situation. The majority of software and internet companies are seeing setbacks from lower enterprise and consumer spending, but the bulk of the YTD declines in stock price are being driven by an over-correction in valuations.

The same cannot be said, however, of Stitch Fix (NASDAQ:SFIX). This apparel e-commerce company, which made a name for itself through its novel concept of sending customers a "Fix" of five clothing items that they can then choose to purchase or return, has seen a veritable decline in its fundamentals since the start of the year. Stitch Fix's problems are complex and varied: competition against the reopening of brick-and-mortar, lower consumer spending on discretionary items like clothes, and overall crowdedness in the apparel space.

Year to date, shares of Stitch Fix have lost ~80% of their value. While it's sometimes tempting to try to catch a falling knife, I believe the Stitch Fix cause is lost and that there is further pain to go.

Data by YCharts

I remain bearish on Stitch Fix, and the latest developments from the company's fiscal fourth quarter results (released in late September) don't exactly add to my confidence. In particular, I'm now quite worried about the company's liquidity position: especially as it continues to expect revenue to continue decaying and the cost landscape looking tougher (for Stitch Fix as well as for all other companies in the market).

As a reminder, here are the key red flags I'm citing for Stitch Fix:

• Is Stitch Fix relevant anymore, or is it just a passing fad? The idea of getting a "Fix" of five items and keeping only what you like was the whole selling point behind Stitch Fix in the first place. But declining active customers seem to be suggesting that people don't want this complexity in the shopping process. In fact, Stitch Fix introduced its direct-buy "Freestyle" program to mirror classic e-tailers: and in doing so, it lost its niche in the first place. Without much of a powerful brand to draw from, it's unclear how Stitch Fix plans to remain relevant.
• No clear moat. Stitch Fix's innovative buying method was part of its appeal versus the dozens of e-commerce clothing competitors out there. With the business doubling down on Freestyle, it's unclear what Stitch Fix plans to do to hold onto customer loyalty.
• Weighed down by inflationary pressures. Stitch Fix's gross margins are declining. At the same time, even though the company is letting go of a chunk of its staff, it is also facing corporate wage inflation. The net result is a deep gush of red ink, which is exactly what Wall Street does not want to see in this very cautious stock market.

With a market cap of just <$400 million, Stitch Fix is usually in a position where many tech stocks hope for a rescue by a larger competitor or a private equity company. In Stitch Fix's case, however, the souring fundamental performance that we've seen with each passing quarter plus what I view to be a devaluation of Stitch Fix's brand equity make this scenario unlikely. The fact that founder Katrina Lake exited the company as CEO when troubles started abounding isn't a comforting sign either (which I view to be in contrast with some other declining tech stocks like Asana (ASAN), whose founder/CEO Dustin Moskovitz recently purchased additional stock).

The bottom line here: I don't see any meaningful near-term catalysts that can help stage a rescue for Stitch Fix. Steer clear here.

All metrics point south; liquidity is draining

Through the end of Stitch Fix's fiscal Q4, all of Stitch Fix's key business metrics indicate that the company is struggling to maintain relevance - and its positioning will get even worse in Q1, which is the critical holiday period.

Stitch Fix key metrics (Stitch Fix Q4 earnings deck)

As shown in the chart above, Stitch Fix's revenue in FY22 declined -1% y/y. Note that this full-year picture is a rather flattering representation of how recent trends are performing; Q4 revenue declined at a -16% y/y pace. Stitch Fix's guidance, shown in the snapshot below, even calls for Q1 revenue to decline to a further -20% to -22% y/y:

Stitch Fix outlook (Stitch Fix Q4 earnings deck)

The company also shed 380k active clients (defined as a customer who made at least one purchase in the trailing twelve months) in the year to end at 3.8 million, down -9% y/y. It lost 112k of these customers in the fourth quarter alone.

Per CEO Elizabeth Spaulding's prepared remarks on the Q4 earnings call, here is the company's plan to reignite customer growth in FY23:

In FY '23, building on our strength of listening and responding to client requests and meeting the moment, we are evolving our stylist request note to include the ability to add specific occasions so that our stylists can deliver stronger choices in these discovery moments. We also plan to insert more opportunities to collaborate with our stylist community in real time.

Additionally, we're working to deliver a diverse assortment that showcases our varying price points especially at a time when consumers are more cost conscious. We believe these efforts will drive higher engagement and further cement Stitch Fix as the go-to online styling partner for both current and future customers.

On to the second point, we recognize that reigniting the active client flywheel is vital for growth. We know that success will not only come through new client activation, but also through prospective clients and reengaging clients who haven't shopped with us for over 12 months. In mid-September, we released our first ever multinational brand campaign with the goal of communicating how Stitch Fix works and celebrating the personalization that we deliver.

While traffic improved through the second half of FY '22, we expect this campaign to drive a sizable increase in impressions across TV, paid social and branded content partnerships, and by building brand awareness will increase traffic to our ecosystem. We also launched an affiliate influencer network in early August."

While we are yet to see the impacts of the company's new brand campaign, the company's guidance and recent trends certainly show that Stitch Fix is losing brand power and "singing to a smaller audience."

We should also watch out for profitability, especially as gross margins declined 400bps in the fourth quarter to 42.5%. Adjusted EBITDA in the fourth quarter sunk to -$31.8 million, versus a gain of $55.4 million in the year-ago Q4; while full-year adjusted EBITDA clocked in at -$19.5 million.

Stitch Fix adjusted EBITDA (Stitch Fix Q4 earnings deck)

Note that Stitch Fix isn't expecting profitability to materially improve in FY23: it's currently calling for -$35 million to -$45 million in adjusted EBITDA losses on a -13% y/y full-year revenue decline.

Keep an eye as well on Stitch Fix's liquidity picture. As seen below, its cash balances have continued declining each year, and the company ended FY22 with just $231 million in cash and equivalents:

Stitch Fix balance sheet snapshot (Stitch Fix Q4 earnings deck)

The good news is that Stitch Fix is currently carrying no debt. But continued margin pressures and losses may force the company to raise additional capital, at a time when the capital markets are effectively closed for struggling companies like Stitch Fix.

Key takeaways

I continue to see no compelling reasons to stay invested in Stitch Fix. The company is losing customers, shedding margin, and seeing its profitability erode. Don't try to catch the falling knife here.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.