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The Market Is Misreading the Stitch Fix Earnings Report

By Jeremy Bowman - Oct 3, 2019 at 7:49AM

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This is what short-termism looks like.

Stitch Fix (SFIX -1.39%) shares fell 11% on Wednesday following the release of the company's fourth-quarter earnings report. 

The sell-off came in spite of a solid quarter. The personalized styling service said revenue was up 36%, or 26% without the extra week in the calendar, to $432.1 million. That was toward the high end of the company's guidance of $425-435 million, though just below the analyst consensus at $432.3 million.

On the bottom line, the company posted adjusted earnings per share of $0.07, ahead of estimates at $0.04.

Despite those numbers, the market sold off the stock on underwhelming first-quarter revenue guidance as Stitch Fix called for top-line growth of 20%-21% to $438-$442 million. That was well below the analyst consensus at $451 million.

However, management clearly explained why revenue growth was expected to slow following a 29% burst in the third quarter and 26% growth in the fourth quarter. It said it had greater success with lower-priced products in the summer, like t-shirts and sleeveless tops, which probably drove down average spend, and it spent less on marketing at the end of the fourth quarter, which had an impact on performance in the beginning of the first quarter.

More importantly, Stitch Fix's revenue guidance for the full year, at $1.90-$1.93 billion or 23%-25% growth, is actually in line with the Wall Street average at $1.91 billion. In other words, relative to analyst expectations, Stitch Fix simply sees some of this year's growth shifting from the first quarter to later in the year. The long-term forecast isn't any worse than expected.

In this case, Wall Street's short-term bias may be a bit understandable -- Stitch Fix clearly has a better window into its performance for the first quarter, which is already two thirds over, than it does for the full year. But by dumping the stock on one guidance-related data point, the market is overlooking the full-year forecast and a slew of data showing the company is strengthening its competitive advantage.

A woman opening her Stitch Fix box.

Image source: Stitch Fix.

Building for the long term

Putting the guidance aside for now, Stitch Fix shed light on a number of initiatives that are helping the company build a long-term competitive advantage.

First, it is expanding on its traditional five-item fix with services like Extras, which allow customers to purchase items like socks and underwear in addition to their fix, and Shop New Colors, which gives customers the ability to buy previously purchased items in new colors, prints, and sizes. Similarly, the company is also testing a new offering called Shop Your Looks, which provides customers with an assortment of 30 to 40 highly curated items based on their previous purchases. In an eight-week beta test, Shop Your Looks has shown considerable promise, and seems to have significant potential to drive top-line growth by giving current customers a reason to spend more on the platform, as well as a new way to engage with Stitch Fix.

Those innovations have come with the help of Style Shuffle, a unique interactive platform that essentially functions as a game asking customers which clothing items they like. Style Shuffle has helped the company's stylists do a better job selecting clothes for its customers, and management also expects it to inform its merchandise buying in the future.

Elsewhere, the company also shared how it's using its marketing spending effectively. Based on gross profit from new clients as a percentage of advertising spend, Stitch Fix showed that the company has already made more than four times its advertising spend back from clients in the second and third quarters of 2018, a sign its marketing budget is achieving its goal of a fast payback.

Beating back the bears

Stitch Fix's stock remains heavily shorted, with a third of the float sold short. And with IPO stocks getting shellacked following the WeWork collapse and the end of the meal kit boom, the market remains skeptical of the personalized styling service despite its steady growth. Investors have shown multiple times that almost any flaw in an earnings report, including slowing user growth or quarterly losses, can be a reason to ignore the good news and sell the stock. 

However, Stitch Fix's long-term growth target of 20%-25% revenue growth remains very much intact, and given its full-year guidance of 23%-25% top-line growth for the full year, the focus on the first quarter alone seems silly. At this point the stock is starting to look cheap according to some measurements. Based on its forecast adjusted EBITDA for fiscal 2020, excluding stock-based compensation, the stock is trading at a multiple of less than 20. On a price-to-sales basis, it trades at a multiple of less than 1, about 0.95, based on the 2020 forecast. That's much less than TJ Maxx-parent TJX Companies at 1.7, and not that much more than Target or Costco at 0.71 and 0.84, respectively.

It's may take a while for Stitch Fix to persuade the market of its potential, but as long as it can maintain a growth rate of 20%-25%, the company will only grow stronger and increase its competitive advantages. Profits will eventually follow.

Jeremy Bowman owns shares of Stitch Fix. The Motley Fool owns shares of and recommends Stitch Fix. The Motley Fool has a disclosure policy.

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