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3 Reasons Stitch Fix Doubters Are Missing the Big Picture

By John Ballard - Mar 14, 2021 at 10:00AM

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The market committed the classic mistake of losing the forest for the trees after its latest earnings report.

Stitch Fix (SFIX 3.62%) stock plunged 27% following the release of the company's fiscal second-quarter earnings report. The culprit was a slight miss in revenue compared to management's previous guidance and a lower-than-expected forecast for the rest of the fiscal year. 

On the surface, it seems Stitch Fix lost momentum, but the revenue miss was not due to a lack of interest in the company's offering. In fact, Stitch Fix is seeing the highest rate of customer migration to its platform in years. 

After reviewing the earnings report, it's clear that Stitch Fix is still well positioned for long-term growth. Here are three reasons why the market got it wrong.

A man's hands unpacking clothes from a box.

Image source: Getty Images.

1. Revenue miss caused by shipment delays

Revenue came in at $504 million, good for an increase of 11.6% year over year. Stitch Fix had previously guided for revenue between $506 million and $515 million. It might seem silly for a stock to lose nearly a third of its value because the company missed revenue estimates by a few million, but that's why it's imperative to never make assumptions about a business based on stock performance.

The knee-jerk reaction by the market seems irrational when you realize that the revenue miss was simply related to how Stitch Fix recognizes revenue.

The company recognizes revenue when a client decides to keep an item from a fix and checks out. It does not recognize revenue at the time a fix is shipped, so there is usually a small delay when revenue is recognized after a client requests a fix.

However, that delay was longer than usual starting in November and continuing into February due to the recent spike in COVID-19 cases. This means some of the revenue that would have normally been recognized in the fiscal first quarter (which ended in January) was carried over to the fiscal second quarter. 

Stitch Fix also experienced softer demand for its direct buy offering due to seasonality during the holidays, but the main problem was carrier delays. "Adjusting for the impact of these increased cycle times, we believe Q2 revenue would have been within our guidance range," founder and CEO Katrina Lake said during the earnings call. 

2. Delaying the launch of new product features

The stock surged to new highs following the previous earnings report in early December. One of the reasons for that was management's guidance calling for revenue growth to accelerate to a range between 20% and 25% year over year in fiscal 2021. But management revised that down to a range between 18% and 20%, which it blamed on the delay in launching direct buy to new clients. 

Stitch Fix's direct buy service has been resonating with existing clients, and management was planning to introduce this offering to new clients this year, which would have expanded the addressable market and boosted revenue growth in fiscal 2021. 

The company now expects some product features related to direct buy to launch toward the end of the fiscal fourth quarter, which will push out some of the anticipated revenue growth into fiscal 2022. But this only means that there is more growth to look forward to in the next fiscal year.

The delay in rolling out direct buy for new clients should lead to even better results when it's available. In the near term, Stitch Fix will improve the user interface and expand the breadth of the assortment, among other operational improvements. 

"The momentum and client engagement we've seen increases our confidence as we look to introduce direct buy to new clients at the end of the fiscal year," President Elizabeth Spaulding said. 

3. Active client growth

The growth in active clients is the most important metric investors should watch in the near term. While carrier delays could continue to negatively impact revenue growth, the number of new clients signing up doesn't lie -- it reflects the real momentum happening in the business.

At the start of the pandemic in March 2020, active client growth had been at 17% year over year during the previous two quarters. But once the economy shut down to help stop the spread of the virus, active client growth plummeted. 

Metric Q2 2021 Q1 2021 Q4 2020 Q3 2020 Q2 2020 Q1 2020
Active client growth 12% 10% 9% 9% 17% 17%

Data source: Stitch Fix earnings releases. The company's fiscal year goes through July. 

Since bottoming out at 9%, active client growth has started to accelerate back to double-digit rates recently, reaching 12% in the last quarter. What's more, growth in first-time fix shipments from new clients accelerated to nearly 50% year over year in fiscal Q2, up from over 25% in the previous quarter. 

Lake sees this performance as a good indication that Stitch Fix is well positioned to benefit from the consumer migration to e-commerce right now. "Given that our women's category comprises a large majority of our business and addressable market, this acceleration is particularly exciting and highlights our strong product market fit and the migration that is under way," she said. 

Stitch Fix is fine

I would only get concerned if active client growth started to decelerate sharply in the face of a strong economy, which would signal that Stitch Fix has run out of gas. But the company is still attracting new clients to its platform and that should lead to an acceleration in revenue per client over the next few years, especially once direct buy is available to all clients. 

Stitch Fix remains a great e-commerce stock to consider. The trend in active client growth is moving in the right direction and there remains a massive opportunity for Stitch Fix to capture more share of the apparel market over the long term.

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