Stitch Fix (SFIX 2.65%) shares have doubled in less than two weeks.
After underperforming the rest of the e-commerce sector over the pandemic, the stock surged following a better-than-expected earnings report and strong guidance for fiscal 2021. Shares also seemed to get a boost from a short squeeze -- at the end of November stocks held short accounted for 41% of shares sold, showing bears were eager to line up against the stock coming into the December earnings report.
After doubling in just a few days, it may seem like Stitch Fix shares are now overvalued, or at least that a once-undervalued stock is now fairly priced. But the stock still looks reasonably cheap when measuring a few conventional metrics.
Image source: Stitch Fix.
Valuation
Stitch Fix isn't an easy company to value. As a pure-play online styling service, the company doesn't have any true peers, or at least not any that are publicly traded. The closest analog may be Trunk Club, a similar service owned by Nordstrom, but we can't compare the two on valuation.
As an e-commerce company, the best comparisons would come from other consumer-facing online retailers. The chart below shows how Stitch Fix compares in price-to-sales ratio, one way of valuing high-growth stocks that still have slim profits.
| Company | P/S Ratio | Business focus |
|---|---|---|
| Wayfair | 2.3 | Home furnishings e-commerce |
| Revolve Group | 3.5 | Influencer-driven fashion e-commerce |
| Stitch Fix | 4.1 | Online personalized styling service |
| Amazon | 4.7 | E-commerce and cloud computing |
| RealReal | 5.4 | Online consignment |
| Farfetch | 14.1 | E-commerce marketplace for luxury fashion |
| Etsy | 17.7 | Marketplace for artisan-made products |
Source: YCharts
Farfetch and Etsy are both online marketplaces, which explains why their valuations are much higher, as those businesses have lower revenue than direct sellers -- they focus on marketplace sales, measured by gross merchandise volume.
Of the rest of the group, Stitch Fix falls smack in the middle. And unlike peers such as Wayfair and Amazon, Stitch Fix's revenue has been artificially deflated by the pandemic: It suffered from warehouse closures and a softening in demand, as its clothes are generally intended for professional settings and social occasions. The company sees revenue growth jumping as much as 40% in the second half of its current fiscal year after lapping the challenges from earlier on the pandemic. At Wayfair, on the other hand, analysts expect revenue growth to slow to just 12% in 2021, and it could even see quarterly declines on comparisons with the highest-growth quarters of the pandemic. That means that Stitch Fix's P/S valuation on a forward basis is much closer to Wayfair's than it appears on the chart above. Similarly, Amazon's revenue growth is expected to slow from 35% this year to 18% in 2021.
Profitability
Bears seem to believe that Stitch Fix is a cash-burning machine destined to fail, but that's far from the case. In its two fiscal years before the pandemic, the company delivered a solid profit on a generally accepted accounting principles (GAAP) basis, with a $36.9 million net income in fiscal 2019 and $44.4 million the year before.
Profitability isn't an immediate goal of the company, as it's more focused on tackling an addressable market it estimates to be worth more than $400 billion through its data-driven curation model. Stitch Fix is also targeting long-term revenue growth of 20%-25%, meaning its profits should grow over time, though investments in technology and other areas mean that profit growth will be lumpy.
Stitch Fix's gross margin has historically hovered around 45%, which is higher than that of the typical brick-and-mortar apparel retailer such as Nordstrom or Gap, showing the company does a better job of turning inventory and controlling prices -- giving it more money that it can invest in fixed costs that drive long-term growth or that it can allow to flow to the bottom line. That should help Stitch Fix continue to gain market share from the brick-and-mortar channel.
The opportunity
The recent surge in the stock shows that investors may finally be starting to catch on to the opportunity in front of Stitch Fix. As it emerges from the pandemic, the company is demonstrating strong momentum after posting record sequential growth in active clients, adding 241,000 from the previous quarter to bring its total to 3.8 million. If bears believe the business to be a fad, it certainly isn't playing out that way.
Additionally, the company is seeing strong traction in key internal metrics like success rate, or the percentage of time that a given item was purchased by a client, which reached a record. Successful first fixes also hit a multi-year high, helping to build its customer pipeline.
However, the real potential game-changer is the company's rollout of its Direct Buy program and the upcoming expansion to new clients, which is expected later this year. This will be the biggest test yet of its data-driven model, and will significantly expand its addressable market, as most of its sales currently come from Fixes (the boxes of five items that it sends customers).
In other words, Stitch Fix may just be getting started. The company is less than a decade old, and its data science-based model is unique in the apparel industry. If the "cold start" Direct Buy launch resonates with customers and the company can deliver revenue growth close to 40% in the back half of the fiscal year, the stock could be significantly higher in another year. As a $7 billion company penetrating one of the biggest consumer markets in the world, Stitch Fix still has a ton of room for growth.
