These 5 Growth Engines Are Humming at Stitch Fix

With Stitch Fix's (SFIX 0.47%) stock down 40% from its high earlier this year, the market may be handing investors a nice entry point for the stock. This personalized clothing recommendation company has ambitious long-term revenue growth targets of 20% to 25% per year.  Management is counting on five growth engines to deliver on that promise.

1. Winning more active clients

Attracting quality customers is the number one way for this personal stylist company to grow. In 2019, active clients, which are defined as basically anyone who bought something in the preceding 52 weeks, grew 18% to 3.2 million.

Source: Stitch Fix Q4 2019 shareholder letter  Note: YoY=Year over Year. FY=Fiscal Year. The company's 2019 fiscal year ended August 3, 2019. Other fiscal years end on Saturday closest to July 31 of that year.

The company actively advertises to potential customers, spending 9.6% of its revenue on marketing last year. CEO Katrina Lake says the strategy is "not to acquire clients just for the sake of acquiring clients. We're looking to acquire thoughtfully clients that are going to be successful through our business and that generate quick payback." It plans to invest around 10% of revenue on targeted marketing and branding campaigns in the coming year.

Image source: Stitch Fix

2. Expanding its product offerings

Stitch Fix started in 2011 as a business that only focused on a subset of women's apparel in the U.S. In 2015, women's petite and maternity products were added, along with plus sizes in February 2017. Stitch Fix for men was announced in September 2016 and kids joined the party in July 2018. Even though it doesn't provide data by product category, Chief Operating Officer Mike Smith shared the progress of its newest addition on the most recent earnings call. "We continue to be really excited about kids, product market acceptance with all of our clients, boys and girls with a wide range of ages continues to be very strong." 

Although the kids business is still small, it provides an opportunity to "land" one adult family member and "expand" to an entire household, which Lake calls "a pretty significant advantage that we can leverage."

3. Improving its recommendation engine

Initial experiences with a brand can be the difference between creating loyal customers and losing them. Management knows that a customer's first few fixes need to be a great experience and has been improving its initial success rate. The table below compares the number of items purchased from the first three fixes for clients that joined in 2018 (FY18 cohort) versus those that joined the following fiscal year. 

Source: Stich Fix Q4-2019 Shareholder Letter

Impressively, the first fix for the 2019 cohort was 17% better than the baseline and higher than the third fix from the previous year. Although management didn't directly credit the Style Shuffle feature, it certainly could be a reason for improved results. Launched in 2018, it's a way to collect user preferences via a simple thumbs up or thumbs down from the client's mobile app on clothing items presented. Smith said that "we've collected over 3 billion ratings [from Style Shuffle] with over 80% of our active clients providing detailed feedback." It shouldn't be a surprise that more data results in better matching. 

4. Creating new ways to buy

Stitch Fix has started experimenting with new ways for clients to buy clothes outside of its five-items-in-a-fix format. In March 2018, it announced its Extras program which allowed customers to select and add socks or underwear to their shipment. Style Pass was announced at the same time and provides the option to pay an annual membership fee of $49, avoiding the $20 styling fee. The style pass program has been well received, with renewals at a 70%-plus rate.

Recently, the company offered two options to buy products directly. The first, Shop New Colors allows clients to rebuy items from their purchase history in different colors, prints, or sizes. The second, Shop Your Looks is currently in beta test mode with a limited set of participants. The service presents a preselected list of 30 to 40 items from its personalization algorithm for purchase. Management is excited about the opportunity for these programs to increase "wallet share" per client. 

5. Expanding its footprint internationally

In May of this year, the company placed its first foothold outside of the U.S. by launching its service in the large and growing U.K. market. Euromonitor estimated that clothing, shoes, and accessories spending for 2018 was $72 billion with 21% purchased through e-commerce. The U.K. clothing market is about a fifth the size of the U.S. and expected to grow by 6% annually.

Even though it's still early, management is confident enough in the strategy to invest in inventory and infrastructure to provide both men’s and women's clothing options for its U.K. customers.

Revving the engines to power long-term growth 

Even though active client growth slowed to 18% in FY19 from 25% in the previous year, those clients spent more, driving a 29% increase in revenue. 

Source: Stitch Fix Q4 2019 shareholder letter Note: YoY=Year over Year

For the past three years, revenue grew in excess of active client growth demonstrating its ability to create loyal customers who spend more over time. Despite not providing specific metrics for its growth efforts, Chief Financial Officer Paul Yee spoke with confidence about 2020. "So all of these initiatives come together to reflect our full-year guidance of 23% to 25% [revenue growth]."

But Lake is looking further out and thinking bigger. She has her eyes on 80% of the clothing spend which is still "stuck" in brick and mortar retail. Investors should watch as the company powers all of its growth engines to capture market share in the coming years.