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Stitch Fix Plunges: Is the Growth Story Over?

By Jeremy Bowman - Mar 12, 2020 at 8:29AM

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The once-promising growth stock is now at an all-time low. Is this a buying opportunity or a warning?

Stitch Fix (SFIX 2.66%) stock fell to new all-time lows on Tuesday after the company slashed its guidance for fiscal 2020. The stock plunged as much as 32.6% in the morning, falling as low as $14.30, below its $15 IPO price back in 2017. Wednesday saw even further declines.

Though fiscal second-quarter figures were solid, the personalized online styling service now expects revenue growth of just around 15% for the second half of the year, significantly below its long-term guidance of 20%-25%. On a 52-week basis, the company is forecasting full-year revenue growth of just 17%-19%, down from a prior forecast of 23%-25%. Not surprisingly, the sudden change sent investors heading to the exits.

Management said it was being conservative with its guidance as it dealt with a number of challenges, both internal and external. 

First, the company noted lower average order values in the second quarter, which it believes is a sign of higher promotional activity in the retail industry, as others, like Nordstrom, have noted. It expects that trend to continue in the second half of the year and is also adding more lower-priced items, which will weigh on revenue growth.

Additionally, management sees customer acquisition costs rising in some digital channels like Facebook, which, along with a decision to delay marketing spending around its direct buy program until it improves the tech, product, and positioning around it, is causing the company to pull back modestly on marketing spending in the second half of the year.  

Finally, there are macroeconomic issues facing the company, including Brexit, which has been more disruptive to its U.K. launch than expected, and the coronavirus outbreak. Management said that there's been no material effect thus far from the outbreak, but CEO Katrina Lake believed it was reasonable to expect some.

A closet with Stitch Fix clothes and a Stitch Fix box at the bottom.

Image source: Stitch Fix.

Is this a red flag or a speed bump?

It's easy to see why Stitch Fix stock is plummeting on the news. The company has only minimal profits and has been seen by the market as a disruptive growth stock, as it's devised a unique approach to tackling a $400 billion opportunity in the U.S. apparel market. 

However, there's a big difference between a stock growing revenue close to 25% versus one growing at just 15%, the same rate that U.S. e-commerce is growing overall. At 15% growth, it would be hard to call Stitch Fix a growth stock.

Many of the factors management cited are temporary. The macroeconomic issues like Brexit and the coronavirus should eventually fade away, and the company is in control of its own marketing budget. If and when it chooses to ramp up advertising to support its direct buy initiative, which is centered around Shop Your Looks, that should lead to sales growth acceleration. However, challenges related to the promotional environment, shoppers preferring lower-priced items, and rising costs to advertise on platforms like Facebook may be more lasting. Stitch Fix has also benefited from a strong economy in recent years, and that could change now too, especially if the effect of the coronavirus outbreak is worse than expected.

There's also another reason for Stitch Fix's sell-off today. A certain segment of the market has long been skeptical of the stock, and 44% of the shares are sold short, indicating a significant number of investors are betting on its downfall. As the only online styling service on the market, it has no true peer among stocks and is therefore difficult to value and assess. Bearish investors see the Stitch Fix model as faddish and note that Nordstrom was forced to write down its $350 million acquisition of Trunk Club, a Stitch Fix competitor, in 2016, just two years after its acquisition. The buy-in-a-box model, where services like Stitch Fix choose clothes for you, is still essentially unproven at scale, and it's an open question how many consumers want to buy clothes this way.

Stitch Fix management remains optimistic, noting improvements in data science-driven algorithms, optimism about Direct Buy, and the potential growth in areas like U.K. and Kids. Asked on the earnings call if the company is still targeting 20%-25% revenue growth long-term, COO Mike Smith said there was no change on that plan, elaborating on the guidance, "We're trying to reflect the kind of current trends that we're seeing, to the earlier question, more macro than sort of company-specific challenges, and we feel very confident in things like direct buy and in the future how big an opportunity that is for us."

The long-term opportunity is still there for Stitch Fix. The company should experience some secular tailwinds as more apparel retail stores close their doors, and shoppers continue to move online. Stitch Fix is also targeting a huge addressable market, giving it a broad range of customers to approach. However, the lowered guidance forces investors to ask the question that management has long been trying to avoid: Is the business model and the long-term growth target sustainable?

At this point, investors will have to wait and see if Stitch Fix's revenue growth bounces back in fiscal 2021 to get a clear answer. Management said it was being conservative with its guidance for the rest of the year, indicating the company may outperform its forecast. I wouldn't be surprised if it did, though that will depend on the severity of the coronavirus outbreak, but the company now looks much more vulnerable to a sustained slowdown than it did before the report. 

Given the current market conditions, it may take Stitch Fix at least several quarters to regain investor confidence.

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