Share prices of Stitch Fix (SFIX 3.32%) were down about 22% the day after the company delivered better-than-expected sales results for the fiscal first quarter of 2022. The stock fell after management delivered a soft outlook for the fiscal second quarter, which raises some questions about the company's execution.
For the next quarter, guidance calls for revenue to be flat to up 3% year over year, which is far from what investors expected, especially after Stitch Fix launched its Freestyle service last quarter that was expected to be a growth catalyst.
Image source: Stitch Fix.
There were several items that are contributing to slowing growth in the near term, so let's unpack what happened and see if the investment case for Stitch Fix is still holding together.
What went wrong
Despite revenue growing a solid 19% year over year, management is seeing lower net client additions than normal after launching its Freestyle service in September.
Freestyle is basically a rebranding of the direct buy service the company had been testing for a while. It should be a long-term growth driver since it allows new clients to order curated items outside of a normal Fix. It basically helps change the perception of Stitch Fix as a subscription service, which it is not, to an apparel store that knows your style and fit better than you do.
On the surface, it appears the launch of the service drove great results. Stitch Fix reported an 11% year-over-year increase in active clients and a 12% increase in spending per client. Combining both of those metrics together gives the 19% growth on the top line.
However, management mentioned obstacles related to onboarding new clients. It seems some clients are confused between which options they should try after signing up, such as Fix Preview, which lets clients see what items they are receiving in a Fix before it ships, and Freestyle, which allows clients to buy whatever they want directly from Stitch Fix.
Another issue is gathering information about new clients' style preferences. For Freestyle to work, new clients must provide the company information by filling out a profile. Stitch Fix relies heavily on this feedback to deliver the right product to clients, but only a fraction of new traffic fully completes the style profile, which presents an obstacle.
CEO Elizabeth Spaulding said the company will be investing in the near term to reduce friction for new clients to access Freestyle. The company plans to test new ways for clients to get started on the service without jumping through too many hoops to get their recommendations.
The supply shortage is another headwind in the near term. Stitch Fix finished the quarter with inventory down 13% from the fiscal fourth quarter ending in July. So even if client growth was higher, Stitch Fix probably wouldn't have enough inventory to keep all clients satisfied anyway. It's a difficult situation the company finds itself in heading into the holidays.
I'm not giving up on Stitch Fix
The flattish growth expected in the next quarter looks bad, but what might be getting overlooked is that management mentioned during the earnings call that these are, indeed, temporary problems. Could it be poor execution? Maybe, but Stitch Fix should return to growth.
Management is currently making improvements to the algorithms to combine clients' feedback and style preferences with real-time shopping behavior, which should lead to better client outcomes with the Freestyle service. Spaulding said that the technology investments the company is making now "will pay off in a big way over the long term."
Indeed, it seems these growing pains will make Stitch Fix a tougher competitor once it completes these investments.
I originally bought shares in this top online retail stock over a year ago and have held through the volatility this year. The stock has been volatile ever since its IPO, but I consider myself an investor, not a trader.
Stitch Fix still offers a great value proposition to consumers. It's saving clients time by using machine learning to deliver recommendations, and it's got 10 years' worth of data to build sophisticated algorithms. The U.S. women's apparel market alone is worth $90 billion, so I'm willing to pay the price of holding a volatile stock to see where this industry disruptor is in another 10 years.
