Why Is Wall Street Shunning Stitch Fix but Flocking to Ascena?

In the ongoing saga that is tech's transformation of retail, one of the main plot lines is how e-commerce disruptors are eating brick-and-mortar's lunch. But what's a story without a few good plot twists? This week, a couple of quarterly reports provided them. First, there's Stitch Fix (SFIX -3.20%), the online subscription and personal shopping service, which handily beat expectations on profits but then gave a forecast that had investors leaving their shares on the changing room floor. Then there's Ascena Retail Group (ASNA) -- owner of Ann Taylor, Lane Bryant, Justice, and Dress Barn -- which beat on earnings and produced same-store sales growth twice as strong as expected.

In this segment of the Market Foolery podcast, host Chris Hill and senior analyst Emily Flippen discuss the reasons why these two stocks have taken such sharply different paths over the past year, the simple reason why investors seem to be so mercurial in how they value certain types of e-commerce businesses, and what the future might hold for the apparel retail sector.

A full transcript follows the video.

This video was recorded on Dec. 11, 2018.

Chris Hill: 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.

Emily 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.