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3 Reasons Stitch Fix Could Keep Surging Higher

By Jeremy Bowman - Sep 22, 2021 at 10:45AM

Key Points

  • The company is launching Stitch Fix Freestyle, allowing any customer to shop directly.
  • Stitch Fix Freestyle could be a catalyst for accelerated growth.
  • Despite strong results in the fourth quarter, guidance was weak.

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The stock looks ready to rally following a strong earnings report.

Stitch Fix ( SFIX 0.96% ) limped into its fourth-quarter earnings report on Tuesday. The stock had fallen by nearly 50% since it popped on its last earnings report even though there was no major news out on the stock since then.

However, the fourth-quarter earnings report gave bears a reality check, and served notice that the underlying business is still strong. The stock jumped double-digits after hours as the online styling service posted 29% revenue growth to $571.2 million, easily beating both the analyst consensus at $547.9 million and the company's own guidance at $540 million-$550 million. 

Even better, the company turned in strong results further down the income statement as well. It posted a record high quarterly gross margin of 46.4%, which it attributed to better-than-expected revenue, improved product margins, and lower transportation costs. Adjusted EBITDA came in at $55.4 million, a 9.7% margin and up from $11.8 million in the quarter a year ago. On the bottom line, the company posted a generally accepted accounting principles (GAAP) profit of $0.19 per share, which crushed estimates calling for a loss of $0.13.

Given those numbers, it's easy to see why the stock jumped 16% in after-hours trading. But there are a few reasons why the stock could keep climbing from here.

A woman holding a Stitch Fix box

Image source: Stitch Fix.

1. Freestyle could be a game-changer

Stitch Fix formally announced Freestyle during the earnings report, a new shopping experience that allows any customer, even those who have never ordered a Fix before, to shop from a curated assortment of products based on their style profile, fit, and budget across categories such as casual, workwear, occasion, and activewear.

The company has been working toward this goal for more than a year, testing out what was formerly known as "direct buy" on existing customers. Freestyle offers a number of benefits for both the company and customers. It saves customers time shopping by giving them a personalized selection that other apparel retailers can't match, and it exponentially expands the company's addressable market from anybody who would order a Fix -- the box of five clothing items that has been the company's core offering -- to essentially everyone who shops for clothes, or at least shops online. It should also increase engagement, as curated selections will change throughout the day as inventory is updated.

Stitch Fix has put together an impressive lineup of brands in Freestyle, including Madewell, Levi's, Rag & Bone, Adidas, North Face, Vans, and DKNY, among others. If Freestyle proves popular, it could ignite sales growth.

2. Guidance looks suspiciously weak

While Stitch Fix's fourth-quarter numbers were stellar, its guidance was not so hot. For the current quarter, the company called for year-over-year revenue growth of 14%-17% to $560 million-$575 million. At the midpoint, that would mark a sequential decline in revenue from the fourth quarter. In its history as a publicly traded company, revenue has only declined sequentially once, and that was during the lockdown quarter last year. Additionally, its guidance for the full year called for at least 15% revenue growth, a significant deceleration from 23% in fiscal 2021. 

That forecast is surprising given the tailwinds from the launch of Freestyle and the ongoing economic reopening, which has been delayed by the Delta variant.

Historically, Stitch Fix's guidance hasn't been excessively conservative. But the company's just got a new CEO, Elizabeth Spaulding, who took over in early August, and she may be offering cautious guidance to avoid overpromising and underdelivering. We won't know until the company's next earnings report if that's true, but based on its track record, the macro environment, and the launch of Freestyle, it should be able to top that guidance.

3. It could be primed for another short squeeze

Stitch Fix briefly rocketed past $110 in January on a short squeeze concurrent with GameStop's breakout. Today, 20% of the stock's float is sold short, or 12 million shares, providing plenty of fuel for another pop as bears buy back stock to close out their bets. Based on the average daily trading volume of 1.5 million shares, it would take shorts eight days to cover, another good sign for a short squeeze.

A short squeeze alone isn't a bull thesis, nor is it alone a reason to own the stock, but dozens of beaten-down consumer stocks have rocketed higher this year on short squeezes, engineered by traders on Reddit and other social media forums. Stitch Fix has been highly volatile over its history, with the stock price ranging from $25 $113. It's a battleground stock, and after months of being on the losing side, the strong fourth quarter sets the table for the stock to run higher.

It will take months to see how Freestyle does and what the company's performance looks like versus its guidance, but the upside potential for the disruptive apparel company is considerable at this point, especially after the stock fell by nearly half in the last three months for no real reason.

  
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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