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Stitch Fix Earnings: Time to Sell?

By Jeremy Bowman – Dec 9, 2021 at 7:03AM

Key Points

  • Stitch Fix's guidance called for revenue slowing to a crawl in the current quarter.
  • Early results from Freestyle, the company's direct buy program, are disappointing.
  • The biggest upside now is that the current stock price reflects the broken growth story.

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The latest earnings report was full of red flags.

There's no sugarcoating it. Stitch Fix's (SFIX -3.23%) latest earnings report was ugly.

Shares of the online styling service tumbled 18% after hours Tuesday after the company beat estimates in the first fiscal quarter of 2022, but its guidance for the current quarter was way off the mark.

After revenue posted 19% year-over-year growth in the first quarter to $581.2 million, the company sees second-quarter revenue growth at just flat to 3%, reaching $505 million to $520 million. The holiday quarter is a seasonally slow time for the company, which partly explains the sequential decline in sales. But that's not an excuse for the weak growth compared to the year-ago period, especially as it's lapping a quarter in which vaccines were still unavailable for most Americans. Therefore, the demand for apparel was below normal.

A closet with Stitch Fix clothes.

Image source: Stitch Fix.

Management offered a number of reasons for the slowdown in top-line growth, including supply chain delays, marketing headwinds from Apple's new ad-targeting restrictions, a customer referral program that was less successful than expected, and slowing momentum from the first quarter. In fact, despite strong overall results in the first quarter, the company has just 15,000 active customers from the previous quarter. 

Stitch Fix shares are now down more than 80% from their peak earlier this year, which was powered partly by a short squeeze, and are at their lowest point since the market crash near the start of the pandemic.

With sales growth now grinding to a halt, is Stitch Fix a broken stock? In addition to the guidance, there were a number of warning signs in the report.

Is Freestyle already a flop?

Ahead of this report, Stitch Fix had been hyping Freestyle for several quarters. The program, which the company has also referred to as direct buy, allows customers to shop directly on its website. This service is unlike its traditional Fix model, in which customers receive a box of five items selected by a stylist. The first quarter marked the first time that Freestyle was available to new customers, and opening up that new market was expected to give a lift to the company's sales.

Management said it was conservative with the marketing approach to Freestyle because it's optimizing the onboarding experience, but revenue from Freestyle was up just 40% from the year-ago quarter. That result seems weak considering that Freestyle was just in its infancy then, and that the first quarter of the fiscal year 2021 was significantly affected by the pandemic.

Management said that the rollout of Freestyle led to Fix conversion rates being lower than expected, which was part of the reason why active customers barely grew from the previous quarter. The challenges with the onboarding experience seem to indicate that Stitch Fix is struggling with the basics of its business, including how to explain Freestyle and Fixes to new customers and direct them to the channel that's best for them. The company even called for a sequential decline in customers in the current quarter, a clear sign that something isn't working.

A broken growth story

In addition to the weak second-quarter guidance, Stitch Fix now sees just high-single-digit revenue growth for the full fiscal year, which ends in July. In other words, revenue growth is only expected to be in the high single digits in the second half of the year as well. At one point, Stitch Fix had a long-term revenue growth target of 20% to 25%. Its current forecast is anemic by comparison, especially at a time when the apparel industry is generally strong.

The company's expansions into new markets such as Kids, Extras, Plus-size, the U.K., and Freestyle may have masked weak growth in its existing segments. Management also likes to point to the large addressable market Stitch Fix is penetrating, but that's meaningless if the company is only growing by single digits. Similarly, you can't call yourself a disruptor, as Stitch Fix likes to think about itself, if you don't have the growth to back it up.

After nearly 10 years since its founding and four years as a public company, management talk about "learning" and "early innings" rings hollow. Stitch Fix should understand its strengths and be able to execute by now.

Time to hit the sell button?

I've been a Stitch Fix bull for a long time, but the comments on the earnings call and the guidance indicate a company in disarray and a business model that seems to be unraveling.

If there's any good news, it's that the weakness is reflected in the stock price, as Stitch Fix shares now trade at a price-to-sales ratio of roughly 1.0. I'm willing to wait a couple more quarters, for now, to see how the Freestyle rollout plays out. However, the post-earnings sell-off is clearly warranted. Based on the struggling trajectory of the business, selling Stitch Fix stock here makes a lot of sense.

Jeremy Bowman owns Stitch Fix. The Motley Fool owns and recommends Apple and Stitch Fix. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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