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Why Stitch Fix Sees a Tough 6 Months Ahead

By Demitri Kalogeropoulos - Mar 16, 2020 at 11:33AM

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The apparel upstart just changed its tone about its 2020 growth potential.

Investors reacted harshly last week to Stitch Fix's (SFIX -6.20%) latest earnings report. The subscription-based apparel retailer met management's sales growth outlook and logged another quarter of improving spending trends when it reported second-quarter results for fiscal 2020. However, a few metrics worsened during the period, including with respect to client engagement and rising costs.

In a conference call with Wall Street analysts, CEO Katrina Lake and her team detailed those warning signs, which convinced executives to lower their short-term outlook. Management also explained why they are as bullish as ever about Stitch Fix's global growth opportunities.

Let's take a closer look.

A woman makes a purchase using her smartphone

Image source: Getty Images.

What went right

We grew our active client count to 3.5 million, an increase of 504,000 clients and 17% year over year. In addition, we grew net revenue per active client by 8% year over year, our seventh consecutive quarter of growth and a reflection of our ability to expand wallet share and deliver value to our clients. -- Lake

Stitch Fix's $452 million of revenue translated into 22% growth, which met management's big-picture target. Executives highlighted several wins related to expanding the business, including growth in niches such as menswear and kid's apparel. The early results of its direct buy program are encouraging, too. 

Stitch Fix didn't have to sacrifice profitability to achieve these successes, either. Adjusted earnings surpassed management's forecast, in fact, and the company remains solidly profitable on a GAAP basis.

Investing in new areas

Our strategy is to drive leverage across our existing offerings, while using the cash from those offerings to invest in newer categories. -- Lake

Stitch Fix's broader business strategy is working, executives said, and they highlighted increasing profitability in the core women's category as a prime example of that process bearing fruit. The extra cash from that margin boost gave management resources to invest more in the attractive plus-size niche. "Our healthy cash flows continue to enable us to self-fund our growth while maintaining flexibility," CFO Mike Smith explained.

A tougher period ahead

Now that we've seen a few company-specific but also macro themes play out in Q2, we're leaning more conservatively in the back half of 2020 and shifting our full-year outlook. -- Lake

Stitch Fix lowered its 2020 sales and adjusted earnings forecasts and now sees revenue growing by 18% at the midpoint of guidance rather than 24%. Executives put most of the blame on lower spending by its newest customers, which might be a consequence of price-cutting across the retailing industry. Management said it's likely that this trend will continue pressuring results over the next six months. 

At the same time, it's getting more expensive to acquire these new customers since digital advertising costs are rising. The combined effect of these trends is a higher financial hurdle the company must meet to get a good return on subscriber growth. Overall, that suggests slower active client gains ahead.

Finally, Stitch Fix sees two major macroeconomic trends affecting results through the rest of 2020. Sluggish economic growth in the U.K. is leading to weaker spending than they expected, and the novel coronavirus pandemic, while not hurting sales yet, will likely have an effect. All of these points contributed to management's shift in tone for the second half of the fiscal year.

The key metric to watch as investors try to judge the likelihood of a growth rebound for the business is average spending by new clients. Stitch Fix needs to find a way to deliver value to these subscribers even during more promotional selling environments for the industry, such as the one executives are seeing today.

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