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Apparel Retail Is Nuts

By Chris Hill - Dec 13, 2018 at 8:54AM

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But at least Ascena Retail Group seems to be going in the right direction.

Stitch Fix ( SFIX 0.96% ) fell 30% on weak second-quarter guidance, while Ascena Retail Group ( ASNA ) popped 25% on better-than-expected comps. What in the world is going on?

In this episode of MarketFoolery, host Chris Hill is joined by analyst Emily Flippen to analyze the apparel retail landscape. Plus, the two dip into the Fool mailbag to answer two important questions: What's the rule of thumb when your stock gets bought out? And how come ducks don't get frostbite?

A full transcript follows the video.

This video was recorded on Dec. 11, 2018.

Chris Hill: It's Tuesday, December 11th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, thank goodness, Emily Flippen is here.

Emily Flippen: Thanks for having me back!

Hill: Good to see you! Apparel retail is going crazy today. We're going to dip into the Fool mailbag, but we're going to start with apparel retail because this is nuts. We've got two stocks and a spread of nearly 60% in terms of how they are doing today. It's Stitch Fix and Ascena Retail Group. We'll get to these one by one.

Stitch Fix, first quarter profits came in much higher than expected, and nobody seems to care about that at all. Their active clients grew 22%. That was still a little bit lower than analysts were expecting. Then, compounded by the fact that they come out and say, "Actually, we're not really going to grow that count in the second quarter." That appears to be what's hammering the stock. Right? It can't be the profits. And they missed by a hair on the active client growth.

Flippen: I mean, what world are we living in that our digital online fashion retailer has been hammered, but the classic hard store retail location is doing well? Stitch Fix has not done well today, to say the least. They announced earnings after close yesterday, and it was exactly like you mentioned, slower active client growth. Ultimately, while Stitch Fix has a lot of great things working for it, in terms of the data, the inventory, the stylists, loyal customers, they still need to sell clothes. And when you're not meeting expectations in terms of active client growth, that doesn't bode well for your ability to sell clothes in the future. 

So, it was that, in combination with the fact that we're going into a holiday season, and management said, "We don't really expect to see growth as a result of the holiday season." A little bit understandable. I'm not sure who is gifting clothes. More people subscribe to this as a service for themselves vs. as a gift. So, that wasn't quite unexpected for me. But for a lot of investors, it did not paint a pretty picture.

Hill: No, I agree with that, in terms of what should be expected around the holiday quarter. That being said, I'm pretty sure that on the docket for 2019 is some sort of plan around the holidays, to gift subscriptions, to get new people trying. Because people who subscribe -- Stitch Fix hates that word. They hate that. They say, "It's not a subscription service." OK, fine. But, people who use this service really love it. So, that would seem natural. If they can figure out a way to enable the people who use the service and love it to give it as a gift next holiday season, that would bode well for them. 

I shouldn't pick so much on the Wall Street analysts' expectations as a group, because, as you point out, this is a growth stock. If they're not growing, they're going to get hammered for it. That being the case, this is a stock that is down about 30% today. It is trading for $18 a share and change. Three months ago, it was over $50 a share. Is this a buying opportunity for Stitch Fix? This really seems like one heck of a sell-off in just three months' time. 

Flippen: I've said this before, I spend a lot of time thinking about Stitch Fix, and I think the reason why we see such drastic changes -- $50, $18, those are huge differences in price. I think that's because Stitch Fix is a binary stock. This stock is either going to succeed or it's going to turn into Blue Apron. There really is very little room for a middle ground when it comes to Stitch Fix. 

So, when they do not meet the expectations of a growth stock, the first thing that jumps into investors' minds is, "This is a zero, not a one. This is not ending well on the binary scale for me, so I'm selling off because it's going to nothing," vs. other stocks, when you have bad quarters, a lot of times, people think, "Oh, it's just a bump. It's going to slowly grow." This is a company that's either going to make it or fail in a lot of investors' minds.

If you're one of those people that really loves the service, really believes in their ability to attract people, to retain customers over the long-term, sell that data to get people to buy more clothes, this is an amazing buying opportunity. And I know a lot of analysts here at The Motley Fool support Stitch Fix, love Stitch Fix. I'm sure they're seeing this as a buying opportunity. But I also know that personally, myself, and I know other analysts, disagree. It's a binary stock. I think ultimately, it just depends on which side of the fence you fall on.

Hill: Is your feeling about Stitch Fix personal about Stitch Fix? Or is that the way you feel about binary stocks in general? That, as an investor, you're not interested in binary stocks? 

Flippen: I'm less interested in binary stocks than some people, but it's not an immediate deal-breaker for me. For me, Stitch Fix... granted, I'm not quite their target customer. I don't spend a lot of money on clothes. I just didn't see it. I didn't see them retaining users for a long time. I reserve the right to be totally wrong about that. In fact, you talked about giving it as a gift. I hope my mom doesn't listen to this podcast, because I actually got her a Stitch Fix gift card for Christmas, with the intention of experimenting on somebody who does value convenience over price and would love to get clothes in the mail. We'll see if she ends up retaining her membership.

Hill: So, they do have a gifting program.

Flippen: They have the ability to send a gift card. To me, that's not the best gift. Whenever somebody opens it up, it doesn't have that same exciting feel. You just got a gift card. I think if they were able to implement where I was able to send her first Fix, then maybe, that would be more appealing for people as a gift. But some of that's just awareness. I'm not sure people are aware that Stitch Fix could be a present. So, it'll be interesting to see what they do next year.

Hill: Here's what's going in the other direction today: it's shares of Ascena Retail Group, which is the parent company of Ann Taylor, Lane Bryant, Loft, Justice, and the unfortunately named Dress Barn, as we were talking about right before we started taping. Dress Barn used to be the name of the company, and thank God, they changed it to Ascena Retail.

Help me understand this. This is a stock that's up about 25% today. I get they did better than expected. Same-store were up 3%, which is not huge, but the expectation was for half that. What's driving shares of Ascena Retail? Is it simply, this thing has been beaten down for so long that we're all stunned that they did as well as they did?

Flippen: That's exactly it. I think everybody has forgotten about Ascena Retail, then they come out with this earnings beat, way better than expectations, and people are like, "Oh, this company still has a pulse." I don't think that makes it necessarily a great buying opportunity. But, just the fact that they are not directly going under made investors realize "Hey, maybe the retail space isn't as doomed as we thought."

But, I do think it's important to look at the differences between their different brands and how they performed, because there are stark differences. The benefits really came from the premium in the kids segment. That's Loft, Anne Taylor, Justice for Kids. These are the segments I really saw that growth in, and virtually all of their other segments declined. Justice up 12% for same-store sales, that's insane. I think for them, it's going to be really picking out what's succeeding, what's not succeeding, and relying on those brands to drive growth in the future.

Hill: Over the past year, the delta between these two stocks is nearly 100%.

Flippen: In the same industry.

Hill: It's the same industry. They're both selling clothes. Stitch Fix shares down a little more than 20% over the past year. Ascena Retail up more than 70%. This is bananas! And I look at this and I wonder, particularly in the case of Ascena Retail, OK, they've got all these brands under the umbrella. Should they be getting rid of -- over the weekend, I took my son shoe shopping. The place we went to, right next door was a Dress Barn. You're the second person today who I've said that to, and the reaction, the words out of your mouth, were, "Wow, I didn't even know those were still around."

Flippen: I think they could drop Dress Barn, and I don't think anyone would notice.

Hill: That's the thing. I look at that and go, OK, if you're looking at Justice putting up double-digit comps, if they're doing 12% comps, clearly Dress Barn and some of the others are dragging them down.

Flippen: Of course. It's so interesting. It's a hard segment to wrap my head around sometimes. Retail in itself, I've mentioned this before on the same podcast, I think we have premium and we have cheap now. That middle ground where Ascena Retail wanted their brands to play, that's more challenging. You'll notice that Loft, which posted 9% comps, also posted an increase in the average selling price of their clothes. They were raising the price of their clothes, then having to decrease the price of their cheaper brands, and that increased their sales. So, I think that might be a testament to the fact that, like with Stitch Fix, people are willing to pay a little bit more for premium clothes, or they're going and getting very cheap discount clothes for what they're not buying premium. I wonder if that middle ground is going to exist.

Hill: Our email address is Question from Mike in Ohio. He writes, "I have two questions. I've never had a stock I own be part of a buyout. But what is the general rule of thumb if you own a company that gets bought and the stock subsequently shoots up 20% or more? Do you sell and take the profit? Or hold the stock to own shares of the new company? What are the pros and cons of each?"

Great question! I don't know that there is a general rule of thumb. This has happened to me a couple of times. It just depends. I know that's not a particularly satisfying answer. To his point, what are the pros and cons of each? 

Flippen: You're completely right that it depends. It also depends on the type of buyout. A lot of times, you might get a cash buyout where a company is acquiring another one and it's not rolling into shares of the new company, you're just getting cash in your brokerage account in exchange for that share. In that case, it's important to remember that's a taxable event, first of all. Whatever your cost basis is for that stock, you're going to have to pay taxes on whatever cash you receive. And, now, you have to make a decision about what to do with that extra cash. Most of the time, I think the average premium is about 25%. So, a lot of times, you as an investor are either really happy because you got a premium, or really sad because this might be a company that you loved that maybe no longer exists, at least not in the way that you've known it. 

In this case, he's asking about when it's a stock buyout. The stock shoots up, and the shares that you own are going to translate into shares of a new company. That's when the decision making comes into play. You have to completely redo all your due diligence about that investment. Do you even want to own shares of that new company? In that case, you have to critically think about it, and think, "I can sell this now and roll it into a different investment, I could retain the shares of the new company." It's a personal investing decision.

The question is, when you have a stock and it shoots up 20% and you're trying to figure out what to do in that in-between period, you'll notice that a lot of times, the stock price doesn't directly go up to the entirety of the offer price. That's because there's always the risk of something falling through. So, if you want to cash in that opportunity, mitigate the risk of that buyout not happening and sell, you can do that. You can continue to hold because you love the company and you want to roll it into new shares. It really is an independent investing decision. I will just say that it's important to consider the taxable effects of whatever you're choosing to do.

Hill: It is the proverbial good problem to have. 

Flippen: Yes, exactly. Well, I mean, we also see great companies that we love get bought out. I know, for example, Red Hat recently got purchased by IBM. It's a sad thing for a lot of Red Hat investors because they believed in that company, they believed in the culture, and then you have a company that has a completely different culture coming in and acquiring it. The question is, are they going to continue to do what they're known for doing, what I love that they do? And we don't know. So, it can be a great thing as an investor, you can make a lot of money, but it can also be sad as an investor because you lose companies that really hold a special place in your heart. 

Hill: Here's the second question from Mike in Ohio. I'm going to bring in our man behind the glass, Dan Boyd, to answer this. Not that Dan isn't an investor, but this is not an investing question. And fortunately, it's right up Dan's alley. Mike goes on to write, "How do ducks not get frostbite when they swim in a near-frozen river or lake?"

Great question! Dan, you're a birding expert. Can you help Mike out with this one? 

Dan Boyd: Well, I don't want to call myself an expert here. I don't think I'm an expert, but I know a thing or two. 

Hill: You're an experienced birder.

Boyd: Yes. So, ducks. Ducks are cool. No. 1, you guys know about down, right? Like a down comforter or a down jacket? That comes from birds! Down is the type of feathers they have under their longer feathers that keep them warm in the cold weather. They also have oil that keeps the water off of these feathers, so they don't get waterlogged and soaked down. Also with their legs, birds can control the amount -- at least ducks can, and a lot of other birds can, too. My dad and I were just talking about this this morning when we went out in 25 degree weather to go birdwatching, about swamp sparrows and how they usually always end up keeping one foot in the water as they're forging. They can control the amount of blood flow to their feet, so they don't get hypothermic feet. There's not a whole lot going on in bird feet. There's no muscles. It's just tendons, scaly, tough skin and bones. So, there's not a whole lot of stuff that can get damaged by cold. There you go. Bird facts, here on MarketFoolery.

Hill: You're not getting that on Bloomberg, people. Quick shout-out to Dylan Lewis from the Industry Focus podcast. This morning, Dylan brought in bagels from a new deli in Washington, D.C. with a great name, it's called Call Your Mother. Fantastic bagels and spreads.

Boyd: I can confirm. The bagel that I had was excellent. 

Hill: Yeah. I think this may mean we have to start being a little nicer to Dylan so maybe he'll do this more often.

Boyd: Over my dead body.

Hill: OK, that's fair. Emily Flippen, thanks for being here!

Flippen: Thanks for having me!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

[Christmas Time Will Soon Be Over by Jack White]

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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