Consumer and Retail IPOs of 2017: Where Are They Now?

In this episode of Industry Focus: Consumer Goods, Vincent Shen and senior Motley Fool contributor Asit Sharma catch listeners up on the fates of Canada Goose (GOOS 0.35%), Blue Apron (APRN), and Stitch Fix (SFIX -0.94%) -- all members of the IPO class of 2017.

Find out how these companies have performed since joining the public markets, their latest major developments, and what investors should watch going forward.

A full transcript follows the video.

This video was recorded on June 5, 2018.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, June 5th, and I'm your host, Vincent Shen. I was looking through my show notes from the past year, and I realized that we are overdue for some updates. Specifically, we're going to check in on the status of IPOs from 2017. 

There were a handful of consumer and retail debuts that we covered here on Industry Focus. Coincidentally, three of those companies have seen quite a bit of volatility so far in 2018. For these updates, I'm enlisting the help of senior Motley Fool contributor, Asit Sharma, who's joining us today via Skype. Hey, Asit!

Asit Sharma: Hey, Vince! How's it going? Hello, listeners! I hope everyone is having a great week so far.

Shen: I think you and I talked about two of these three companies originally, and I'm pretty excited to provide some updates to how they're doing, refresh our outlook of these companies. Frankly, we've covered a lot of newsy stories the past few weeks, because there was the Walmart-Flipkart deal, there was Sprint and T-Mobile, there was the Comcast-Disney thing. I'm happy to circle back a little bit on some of these stocks that we've discussed previously and see how they're progressing as public companies. 

The three in question are Canada Goose, Blue Apron, and Stitch Fix. More recently, we also covered the IPOs for Hudson and ADT, but we're going to give those businesses a few more quarters before following up.

The first to IPO was Canada Goose. They priced their deal in March. The stock is up 240% from that initial offering price -- pretty impressive. Just year to date, shares are up over 35%. When we first covered Canada Goose, we were impressed by several things, including the very robust growth that they're enjoying, especially for an apparel company, but also the brand cachet they have, their pricing power, and the multi-pronged approach that management has taken to its sales channels. It has its wholesale partners, but they're also really focused on their company-owned stores, their country-specific online portals. Those last two make up their direct-to-consumer business. Management has really focused on growing out that segment, which happens to command much higher margins than the wholesale business.

Asit, what's the latest going on with Canada Goose?

Sharma: The latest that we probably want to pay attention to is something that you just mentioned, Vince, it's those margins. As we talked about when we first covered this stock, it's a high flyer, but it's increasing sales -- and gross margins, profit margins, as well -- at a rate that justifies a little bit of a steep valuation, which we'll get to in a moment. 

One thing that caught my eye in the company's latest earnings report -- actually, we're due for a new quarter. Canada Goose tends to announce its earnings six or seven days before they actually put out the earnings. I don't have a firm date for listeners, but within the next two weeks, we'll have another quarter reporting. But in the most recent reported quarter, which covers the three months for their fiscal year ended Dec. 3rd, 2017, gross margin increased about 600 basis points, that's basically 6 percentage points, to 63.6%. I love this. This is the trend that we talked about last time we covered Canada Goose, in that this shift from its initial wholesale channel, which is where the company gradually built its space, to this direct-to-consumer type of sale, online, through its flagship stores. The company is really pushing its margins forward, and that's giving earnings a chance to breathe and increase so the stock can work its way into that valuation.

Shen: I was really surprised, looking back at my notes from that last show. I want to remind listeners that this company has managed to grow this direct-to-consumer business almost tenfold in just a few years' time. The latest figures that we have from the company at this point, they're a little dated, as we wait for the updated numbers, but the company pinned the DTC segment at almost 30% of total revenue previously, those numbers being from the end of 2017. I expect the next report brings that figure quite a bit higher. Again, I'm very interested in seeing, like you, how that's going to continue to change the profile of their margins.

Sharma: Sure. I wanted to point out that the company has a long-term path to keep pushing those margins forward. Recently, the CEO, Dani Reiss, said that the company wants to produce half of its goods in-house within the next few years. If you look at today, they're producing about one-third of goods in-house, and they use different suppliers for the rest of their product. But the company is expanding its base. It's added about 700 employees in the last year. The former base was 1,350. It's opened a new production facility -- I know I'm going to pronounce this wrong. The facility, which was opened in June of 2017, is in Boisbriand, Quebec. Listeners, please write in if I really mangled that. What the company is trying to do is keep these in-house value-added components of the manufacturing process, and then open more stores. 

Last week, the company announced its China strategy. Now, it's opening two flagship stores in China. There's often talk on this show about that aspirational Chinese consumer who has more disposable income and loves luxury goods. The stores are going to be opened in Beijing and Hong Kong. The company is also opening an Asia office in Shanghai, so more manufacturing in-house and an expansion into markets where I think its high-end products will be well-received. These are all ways in which this company can justify that high price. And I looked at the chart this morning, Vince. It's been a steady ascent since the last time we covered this stock, hasn't it?

Shen: Yeah. It's definitely a standout for the consumer and retail space and for apparel in general. Really can't beat the share price performance that Canada Goose has managed to deliver. The latest news, what you mentioned in terms of the expansion plans that they've announced for China, I think they're going to go into more detail on those beyond what they shared in the press release when they report their next quarter of results. Basically, this is the company formalizing their approach to what they call "the world's largest luxury market". They've already seen healthy demand from Chinese consumers, and now they're appointing this president for the Greater China region, as you mentioned, opening the office, the two stores in Hong Kong, Beijing. They're also working with Alibaba and Tmall for their e-commerce push in that market. 

The last time we talked about this company, that was an example of the expansion opportunities that we saw for Canada Goose, in that they could expand geographically, and then also in product categories, since the brand has historically focused on outerwear. It's really good to see them laying out the plans for such an important market like China that comes up all the time on this show as a region that's very exciting, showing a lot of growth and potential for companies across the various sub-sectors in consumer and retail.

The last thing that I think we should cover before we move on, this is something that, last year, when we were talking about the company, I was a little bit more skittish about, and that's the high valuation. Right now, shares trade, I have at almost 80x forward earnings estimates. That's not too far off from where we were the last time around. I have to admit that, with this update, I'm still really impressed by this business. I'm a little closer, I think, to coming around for this stock, in terms of the valuation, but part of me still thinks fashion trends, apparel can be a very fickle industry. But when you have a management team that's very disciplined, that they prioritize the brand positioning first and foremost, because that's something that's so difficult to build up, even if you have a ton of money to spend, I think it's good to see the discipline they've maintained there. 

Even if growth does level out for this company over time, I think I'm much closer to giving this company a bullish recommendation, for example, for the next five to ten years. Those are pretty solid investing horizons for Fools to consider. I'm curious what you think, given the premium that this stock trades at, if your position has changed.

Sharma: My position hasn't changed. I'm still optimistic on this stock. But look, let's be honest, this is a company that's 60 years old, and it's built its really high-end product very gradually over decades. It's a really recent entrant into the public markets, and we all know, investors, you've seen a company that just zooms up the chart and has one quarter where it "misses earnings expectations". This is probably ripe for a pullback at some point in the near future. 

However, I don't think investors should be rattled. One thing I love about Canada Goose is, it's very methodical in how it expands its business. Another piece of recent news is that the company has filed, I'll call it a draft prospectus, to raise $1.25 billion in the Canadian markets, its home base. It's going to use this most likely for expanding production and building out more of these flagship stores. But it doesn't need this cash right now. In fact, in the announcement of the draft, it's given a wide array of ways it can actually raise that money, be it debt, new stock issuances, warrants. It's basically planning for that long term. 

Be prepared, listeners, if you own this stock, at some point, it must retrace. Everything that rises has to come down at some point before it rises again. That's just a principle of the stock market. All in all, I'm with Vince, five to ten years, I think you have a solid investment here.

Shen: I'll just end on this note in that, some of the, for example, investments that you mentioned in terms of their manufacturing base, things along those lines, I think as they develop some of that infrastructure, the company can increase its scale, have more control and flexibility with each new store it opens, each new market that opens, each e-commerce portal that it launches. And I think that's going to be very important, having some of that control, being able to fine tune, in terms of what, ultimately, a customer who buys, for example, a $1,000 parka from Canada Goose expects is really consistent, high quality. That's something that's part of the brand cachet. So, having the discipline there, the control there, I think, is really important long-term for the company, to make sure it's able to manage and nurture what I think a lot of people would argue is the most important part of the business, being its brand and the reputation that it's developed.

Next up, we're going to continue revisiting our consumer and retail IPOs. We'll be looking at Blue Apron and Stitch Fix. Our next update is for Blue Apron, which priced its IPO in June. This has been a pretty tough story to follow, because Blue Apron, at a time, was the vanguard of meal kit delivery companies. It was a member of the very coveted unicorn list, so it was a private entity worth over a billion dollars. But the stock has seriously underperformed in the past year. Shares priced at $10, and they're currently trading at about $3.30 per share. That's actually an improvement from where they were trading when they were under $2 earlier this year. 

We did a deep dive on Blue Apron before the company officially went public. That episode was actually aired exactly one year ago to the day. But even looking at that early deal prospectus, we mentioned some of the red flags, in terms of their ballooning expenses, lack of pricing power, low barriers to entry. At the time, Blue Apron was the premier name in meal kit services. But if you look at this from a food and grocery perspective, it's tiny compared to the really big competitors out there. I think it makes the company a bit of an easy target as a result of that. 

With all of that, Asit, I'm curious to hear what has jumped out to you in terms of recent developments and the outlook for this company.

Sharma: Those who follow this company closely will remember that about two quarters ago, CEO Brad Dickerson said, "We're going to cut back on our marketing spend, because we're churning through cash, and we need to stabilize our profit margins." Vince, you had telegraphed this when we first spoke about Blue Apron, in that they have to spend a tremendous amount per customer. In this last quarter, which was just reported on, this is quarter one of 2018, they reupped their marketing spend and were able to increase revenue 5% on a sequential basis, so they had to compare it to the prior quarter. Re-upping that marketing spend, they still finished with a decline of 20% in revenue to $197 million. That generated a loss of $31 million. I want to point out to listeners that quarter in and quarter out, Blue Apron has a quarterly cash burn of about $20 million.

There's a fundamental problem with the economics here of the company. Even though it's cut back on its expenses, and even if you cut the company some slack for having some hiccups in their distribution facilities, customers have decreased year over year from just over a million customers to 786,000 customers. The company has had to sacrifice some of its base while it pulled back on marketing. In the meantime, it's faced with a lot of competition. Its cheap rival, HelloFresh, just raised their annual revenue estimates for 30% to 35% growth, so they're going in a total different direction. We also have Kroger buying a company called Home Chef, another competitor, for a range of $200 to $700 million. And of course, last year, Albertsons bought Plated, another rival. I feel that the overarching story on this business is one of poor economics and very stiff competition for market share. What are your thoughts, Vince?

Shen: I was looking at the company's first quarter results. All you have to do is just take a glance at it, and you get a pretty clear picture of some of the challenges that this company is facing. You mentioned revenue being down 20% year over year. Both customers and orders are declining. This comes as the company has tried to rein in some of its marketing spend to help reduce losses. Just an example here, that line item, in terms of the marketing spend, decreased from $60 million, I believe, to $40 million in the quarter. There's a very clear effect on the business with almost a quarter of Blue Apron customers leaving the service. You mentioned from a little over one million to less than 800,000. That's a huge shift, and a very highly, highly correlated effect there. 

You have to wonder what kind of situation is out there where this company can rally long-term. It's not like the meal kit space is becoming less competitive. You have new companies jumping into it, you have established big names in grocery snatching up companies, going through their own acquisitions, as you mentioned. For a company this young, I think a lot of investors can forgive even quarter after quarter of losses. But when there's no top line growth to offset that, I think it's easy to see why the stock has had such a hard time. In 2016, revenue was about $800 million, and that was 130% growth over the prior year. Then, in 2017, investors saw that momentum almost stop in its tracks, which revenue up just 10%. With all that said, though, the stock did rally after earnings last month, basically because Wall Street was expecting even worse losses than what the company ultimately reported. 

Asit, I think you and I are on the same page when I say that investors should ultimately remain pretty wary of this business. When you have a declining customer count, you have revenue per customer pretty much stagnant, and the fact that Blue Apron has to spend, I think, over $150 or more to just acquire a new customer, I really don't see a light at the end of the tunnel here barring some type of acquisition or major influence from outside the company. What do you think?

Sharma: Yeah, acquisition may be the best bet for Blue Apron. I know there's probably a listener out there asking the question, "What about Costco?" We did hear that Costco is doing a pilot in a limited number of stores with Blue Apron's meal kits. And to that, I say, we'll have to wait and see. It's not an exclusive relationship. Costco has other meal kits that are available. And it doesn't preclude Costco from going with competitors. This is simply a test. Although, if Blue Apron can gain wider distribution within Costco, that could help with some of these cash burn issues that we talked about.

Shen: Yes.

Sharma: In the future, maybe Costco is a likely acquirer of Blue Apron. But I would be careful here, for those who aren't invested in the stock and maybe want to get in, seeing it as a value play. Your likely only exit in that case is an acquisition. Even at these levels, I still feel, as you do, Vince, there's risk in the stock. And sometimes that's the unfortunate penalty that pioneers pay in an industry. They are the most susceptible to competitors coming in and taking market share. They're also ones that are leaping to their IPO with a lot of fatigue, just trying to get over that hump and get a little more funding to keep going, not always enough.

Shen: We have a few more minutes here. I want to make sure we have enough time to talk about our last company, and that's Stitch Fix. They will round out our discussion. Stitch Fix was the most recent to debut. Their IPO priced in November. The stock has only been trading for about half a year. Shares are up, though. They priced at about $15 -- they're now trading at over $19 per share. The stock has actually shed a lot of the gains that it managed to rack up earlier in 2018. When fellow Fool Adam Levine-Weinberg and I talked about Stitch Fix last year, some similar themes actually came up that we've already mentioned for Blue Apron, in that you have a subscription-based business with, at the time, strong growth, and also a need to increase marketing spend to reach new customers. That actually spun Stitch Fix's bottom line around from a $33 million profit in 2016 to about break even last year. I'm curious to hear, Asit, what has been some of the big developments lately that have jumped out to you?

Sharma: Vince, the company is still growing its customer base, and that is a trailing phenomenon of this great word of mouth it has. This last reported quarter, Stitch Fix is going to come out with new earnings on June 7th. Again, we're going back quite a while here. But as of three months ended Jan. 27th, 2018, the company grew its client count to 2.5 million. That's an increase of 31% over the prior year, or nearly 600,000 customers. Revenue grew to $296 million, and that's 24% year over year growth. I like the strong growth story. And I actually like that it's both cash flow positive and profitably from a GAAP net income basis, although we're looking this quarter to see if that equation maybe buckles a little bit and we see a slight loss. 

What Vince mentioned is this need to up the spend to now move from a word of mouth phase to an aggressive capture market share phase. In its most recent quarter, Stitch Fix spent $19.8 million on advertising. That's versus $10.2 million in the prior year comparable quarter. That's an increase of 94%. In the first half of the fiscal year, it spent $48 million on advertising, versus $25.5 million. That's an 88% increase. Like many of the companies that are in this so-called subscription box model, marketing, advertising is the key to capturing customers. 

Now, I will say that Stitch Fix has a more analytical, data-driven, algorithmic approach to everything it does. The CEO, Katrina Lake, is a graduate of Harvard MBA School, and she is very keen on using data and analytics to drive everything the company does, from choosing inventory to finding reorder points, to how the company markets online. I do believe it has a little bit of an edge over a company like Blue Apron, in that its marketing spend may be more efficient. The company certainly knows its customer, it's a more specialized product than a meal kit system. Maybe, Vince, I'll let you refresh listeners on the nature of its ordering and product cycle.

Shen: Sure. The last thing you mentioned, in terms of that analytical focus, is probably the main thing that, when I was learning and getting up to speed on Stitch Fix originally, that really caught my eye. Management is incredibly focused on using data. And that really just doesn't come up quite as often in conference calls and in financial filings for other apparel companies. It's kind of a unique situation here. 

The CEO, she spoke at a conference not too long ago, I think three weeks ago. They spent a decent amount of time talking about how, for example, with the data that they have for a customer, and based on all of the input and feedback that they've received, they can come up on a situation and say to themselves, "We believe that there is a 20% probability that the customer will like this one item and a 90% probability that they'll like this other item." To be able to even make that kind of statement, I think it's rare in this industry. 

And of course, that approach, you mentioned inventory management, they know, based on their subscriber base and the demand that goes with that looking ahead, exactly how many pairs of jeans to order, how many sweaters to order, what sizes. That kind of granularity, I think, can be very effective for a company to run efficiently and to maximize how much customers are satisfied, essentially, which each Fix or order that they receive, whether it's month to month or every quarter or whatever it is. 

So, a few opportunities that have come up for the company, as we look forward. They're in the early stages of their men's business and expanding into that. That right there is basically doubling the size of their target market. They've also spoken about expanding into plus sizes, and how, I think they mentioned that 50% of women in the U.S. are at size 14 or higher. They were only previously servicing up to size 14, so again, really expanding their customer base in that way. 

And they're testing other early efforts, things like a pass where, currently, if you receive a Fix, there's a flat fee of $20 charged to you for the styling that's associated with that. If you purchase an item, they'll take $20 off the cost of that order. If you don't, you have to pay the $20 upfront. They've noticed -- again, through some of the analytics -- that for their best customers, people who are purchasing every month, for example, that isn't the best way for them to structure their pricing. So now, they might charge a flat fee of $45 a year, for example, for all the styling fees for a customer in a given period of time. And with that, they'll find that the overall revenue for a customer rises thanks to the change in that system.

I really like to see that the company is experimenting. They're expanding not only the target market but also the kind of products that they're offering customers, finding more partnerships with different apparel brands. In terms of the subscription industry, that space, this is definitely a really interesting company to follow, I think, that has unique situations that you just don't see in apparel otherwise. This is a company that I've been following pretty closely since their debut, and it's been fun to see their progress. I'm very much looking forward to seeing their results coming up in just a couple of days. Any final thoughts from you, Asit, on the company before we wrap up here?

Sharma: Absolutely, I have two. Listeners, when you see this report coming out, focus in on that advertising expense and compare that to overall revenue as a percentage versus the last quarter. That will be very important, because we're trying to get a sense, as these quarters roll on, on how much the company will need to spend to attract its customers. 

The second thing is: Don't become too concerned with the fluctuations in customers. Unique to this company, there's a really lumpy pattern of how its customers order. When the company issued its S-1 registration statement, before its IPO, CEO Katrina Lake, as I mentioned, had a very interesting observation. She just recounted this on a recent conference call, that over 660,000 of the customers of Stitch Fix won't use the service for four months or longer, and then, to use their terminology, they need their Fix. [laughs] So after four months, "I have to have my Stitch Fix!" and they'll reengage. So while we're used to seeing stuff very linearly -- we talk about companies like Blue Apron and look very closely every quarter, well, how did the customer metrics change -- don't get too caught up in customer metric changes from quarter to quarter with this company. You're going to have to watch it for a period of a year or two years to really get a feel for the rhythm of how the customers engage. I think that's, to me, one more positive about this company. Customers seem to be loyal. They're fashion-forward, and obviously they're being provided with things that really satisfy that itch or craving for a curated fashion experience.

Overall, I too am curious and positive on Stitch Fix but need more data. As we always say with IPOs, it's a several-quarter exercise to figure out, ultimately, whether it's a long-term holding or not. But so far, I'm pretty positive on the company.

Shen: Yeah. I'll take one more minute here, because I'm really glad that you brought up the kind of retention and how the company looks at that. They did talk about churn during that conference that I mentioned from last month. I think this came up the last time we talked about Stitch Fix, the idea where you have Blue Apron, where, people have to eat every day, obviously. If somebody is ending their subscription with Blue Apron, they're simply going somewhere else. But the way management at Stitch Fix looks at their product, if they're doing a good job, there's going to be a point where their customers simply have a whole wardrobe, or their budget is tapped out for new clothing, and they're going to stop that. The company is very careful not to overload a customer. They're really thinking about the long-term relationship, in terms of becoming a partner with their customers and how there might be a time when they stop their Fixes, but when they're looking for that fresh item or items for their wardrobe again, they're going to come back to Stitch Fix, so long as they continue to have a good experience with the stylists and the items they're getting. And that, I think, is a good long-term focus for management to have. 

But that's all the time that we have for today. Thank you, Asit, for joining us!

Sharma: Thanks very much! Appreciate it, Vince!

Shen: Fools, thank you for tuning in. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!