Share prices of Stitch Fix (SFIX -2.28%) took another big tumble after the company reported earnings results on March 8. The fiscal second quarter was consistent with previous guidance, but the forward outlook for next quarter was lower than investors expected. Revenue is expected to be down between 10% and 7% year over year for the fiscal third quarter ending in April.
The stock has lost nearly half its value since the beginning of the year, but at a market cap of just $1.1 billion, the stock could be trading significantly below the company's long-term value.
The market is overlooking that Stitch Fix's current struggles are self-inflicted wounds that can be corrected. Let's unpack what happened and why the stock is a bargain.
Image source: Getty Images.
What went wrong
Revenue increased 3% year over year in the quarter, driven by an increase of just 4% in active clients. This is a sharp deceleration over the company's performance prior to the pandemic, when revenue and client growth was consistently in the double-digit range. In the fiscal second quarter of 2021, the company was starting to see its revenue recover from the collapse during the start of the pandemic.
| Metric | Fiscal Q2 2022 | Fiscal Q2 2021 | Fiscal Q2 2020 |
|---|---|---|---|
| Revenue growth (YOY) | 3% | 12% | 22% |
| Active client growth (YOY) | 4% | 12% | 17% |
Data source: Stitch Fix. YOY = year over year.
Stitch Fix launched its new Freestyle offering in September. This new service allows clients to shop directly from the company's inventory like a regular apparel store without going through a human stylist. Clients fill out a style profile, rate some items with a thumbs-up or thumbs-down, and Freestyle shows the client items from top brands that are consistent with their tastes.
To promote Freestyle after launch, management chose to direct traffic visiting its homepage to the Freestyle experience. As a result, this created friction in the onboarding of new clients coming for the regular fix experience, where a stylist handpicks items based on the client's style profile. Management has since corrected this misstep and is now directing clients to an easier onboarding path.
Freestyle is resonating with existing clients
This doesn't diminish the massive growth opportunity Stitch Fix has with its new styling service. Revenue from Freestyle grew 29% year over year in the quarter -- much faster than the rest of the business. It's no coincidence that spending per client surged to a new record, up 18% year over year to reach $549.
| Metric | Fiscal Q2 2022 | Fiscal Q2 2021 | Fiscal Q2 2020 |
|---|---|---|---|
| Revenue per client | $549 | $467 | $501 |
| Change (YOY) | 18% | (7%) | 8% |
Data source: Stitch Fix.
The record spending per client hints at the opportunity with Freestyle. "As we've shared in prior calls, we believe the [total addressable market] potential is two to three times larger than the fix business alone," CEO Elizabeth Spaulding said during the recent earnings call.
It's evident that the rollout of Freestyle was an execution problem on management's part, but that's good news if you're an investor because it means this error can be corrected. Once management figures out the best way to market the distinction between its fix service and Freestyle, the company should return to double-digit growth.
The stock's upside
Stitch Fix has collected 9.5 billion ratings from its clients within its app. This means Stitch Fix knows what its customers want perhaps better than other top apparel brands that trade at much higher market caps.
SFIX Market Cap data by YCharts
Over time, Stitch Fix could bring in struggling apparel brands and improve their performance by leveraging the deep amount of data it has on its clients. Stitch Fix has a powerful competitive advantage in this regard, and that's why the stock looks significantly mispriced at a low market cap of $1.1 billion.
