According to data from the U.S. Census Bureau, clothing and apparel companies have been some of the hardest hit parts of the retail industry in 2020, with sales down 35% through September compared to a year ago. Not even growth stories lululemon athletica (LULU 0.77%) and Stitch Fix (SFIX -1.79%) have been exempt -- although both continue to gobble up market share at the expense of rivals. Both apparel stocks are solid investments, although one looks like the more timely purchase right now.
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Two business models, two growth profiles
Stitch Fix makes money by curating and shipping boxes of clothing to customers, as well as a newer direct buy feature that allows customers to directly search and purchase clothing online.
The Stitch Fix story is an intriguing one because it caters to its patrons' demands using data science to make relevant recommendations. These software algorithms have won over some loyal fans, and provide this tech-driven retailer with plenty of growth options in the future. Since going public in late 2017, Stitch Fix's revenue is up 75% -- including an 11% increase in its fiscal Q4 2020 (three months ended August 1, 2020) to $443 million -- and shares are up nearly 90% during that same span of time.
But many consumers already know what they want, and a fast-growing number want Lululemon. The maker of athleticwear and athletic-inspired apparel has doubled its sales over the last five years, and shares are up over 540% as the company's profits have surged (more on that in a moment). The impressive run includes just a 2% year-over-year revenue increase in the company's fiscal Q2 2020 (three months ended August 2, 2020) to $903 million.
Lululemon's momentum has certainly been slowed due to the effects of the pandemic, but its emphasis on e-commerce in recent years is still helping it scoop up an increasing share of the clothing industry. Its recent purchase of premium workout display maker Mirror for $500 million also opens up a new avenue for expansion that jives with its activewear roots.
Profit margins and war chests
As the larger and more mature business, Lululemon is by far more profitable, with operating margins of 20% and free cash flow generation (revenue less cash operating and capital expenses) of $427 million on revenue of $3.87 billion over the last 12 months. A steadily rising bottom line explains the stock's epic rise, and justifies the premium 11-times-trailing-12-month-revenue that shares currently trade for.
By contrast, Stitch Fix's operating results are much more in line with those of a growing technology company. Operating margins have dipped to negative 3% in the last year, and free cash flow was only positive $12.7 million (since non-cash operating expenses like depreciation are excluded from the metric) on sales of $1.71 billion. While there is promise of a bottom-line payoff down the road, Stitch Fix nonetheless runs lower gross profit margins on merchandise sold (44%) than Lululemon (52%) in spite of its techie roots. Thus, even though Stitch Fix is growing at a faster pace during the pandemic, it trades for a meager 1.7 times trailing 12-month revenue.
Perhaps that makes Stitch Fix a value worth scooping up. Adding to the relative cheapness is the fact that Stitch Fix had nearly $382 million in cash, equivalents, and investments on balance and no debt at the start of August. The larger Lululemon, by comparison, had $523 million in cash and equivalents (recently reduced by the $500 Mirror purchase) and zero debt. But because it is in profitable territory, its war chest of cash is currently being refilled.
All told, while Stitch Fix may be a long-term value if it can continue growing and unlock profitability as it reaches a larger scale, it still has a lot to prove, and will require investor patience. Lululemon's enduring growth story and highly profitable business model look like the better buy right now -- even though shares trade for a premium.
