7 Reasons to Sell Stitch Fix Stock

Stitch Fix's (SFIX 0.47%) stock is sinking to new all-time lows following its fiscal 2022 fourth-quarter earnings report. The online apparel retailer's revenue declined 16% year over year to $481.9 million, which missed analysts' estimates by $6.9 million. It posted a net loss of $96.3 million, compared to a net profit of $28.0 million a year ago, and the $0.89 loss per share missed the consensus forecast by $0.26.

Those numbers were dismal, but some value-seeking investors might still be tempted to buy Stitch Fix as the stock trades at 0.2 times this year's sales and 70% below its IPO price. However, that's a bad idea for seven reasons.

Image source: Getty Images.

1. It's facing inflationary headwinds

Stitch Fix's traditional customers fill out an online survey with AI algorithms analyzing the results in conjunction with human stylists to select outfits they may like. After paying a "styling fee" of $20, customers receive their first package -- or "Fix" -- containing five pre-selected items and only pay for the products they keep while mailing the rest back for free.

But even this unique business model is exposed to challenges from inflation as customers spend less money on clothing and other discretionary products as other living expenses rise. Higher fuel costs are also boosting Stitch Fix's logistics expenses. During its recent conference call, CEO Elizabeth Spaulding warned that "record inflation levels and a deteriorating retail landscape resulted in slower discretionary spend in apparel," while CFO Dan Jedda said the company was experiencing "tightening product margins from rising inflation." They don't expect those headwinds to wane anytime soon.

2. It's cannibalizing its own business

Stitch Fix's approach is novel, but some shoppers still prefer to pick out their own clothes instead of receiving Fixes. To address that issue, Stitch Fix launched a new feature last September called Freestyle, which lets its customers directly buy curated items. However, that strategy also seems to be cannibalizing the original Fix-based business while pitting Stitch Fix against traditional apparel retailers.

During its earnings call in Dec. 2021, Spaulding warned the company "may experience return impacts of cannibalization" as it rolls out Freestyle. And this week, Jedda attributed the fiscal fourth quarter's 16% year-over-year revenue decline to "softness in Fixes volume, which was partially offset by demand in Freestyle," suggesting cannibalization is indeed taking place.

3. It's failing to gain new customers

Stitch Fix went public in 2017 and continued to gain active clients through fiscal 2021, which ended July 2021. However, that growth ended in fiscal 2022 as its number of active clients (including both Fix and Freestyle shoppers) fell 9% to 3.8 million at the end of the year.

Data source: Stitch Fix. YOY = year over year.

4. Its revenues are declining

Stitch Fix has been trying to offset its slower customer growth by growing its average revenues per customer, which increased 8% year over year to $546 in the fiscal fourth quarter. Unfortunately, that growth couldn't offset its 9% decline in active clients, and its annual revenue fell for the first time since its IPO.

Data source: Stitch Fix. YOY = year over year.

The company expects its revenue to decline 20% to 22% year over year in the fiscal 2023 first quarter and to decrease 10% to 15% for the full year. That outlook is dismal compared to many other traditional apparel retailers, which have also been struggling.

5. Its margins are shrinking, and losses are widening

Stitch Fix's gross margins have remained steady since its IPO, but its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin dropped from 4.4% in fiscal 2018 to negative 0.9% in fiscal 2022. It has also been unprofitable on a GAAP (generally accepted accounting principles) basis for the past three years.

Data source: Stitch Fix.

The company expects to post an adjusted EBITDA loss of $10 to $15 million in the first quarter of 2023 and a loss of $25 to $45 million for the full year. Therefore, Stitch Fix's previous round of layoffs, which reduced its headcount by about 15% with the aim of reducing its costs by $40 to $60 million in fiscal 2023, weren't deep enough to stabilize its bottom line.

6. Its turnaround plan is shaky

To gain more clients, Stitch Fix plans to launch fresh marketing campaigns to simultaneously expand its Fix and Freestyle segments without the cannibalization discussed previously. But at the same time, management plans to rein in its spending to stabilize its losses. It will be difficult for Stitch Fix to maintain that tough balancing act in the current macro environment.

7. Its debt is rising

Stitch Fix ended the year with $213 million in cash and short-term investments, while its debt-to-equity ratio rose from 0.8 in fiscal 2021 to 1.4 in fiscal 2022. That rising leverage (in the form of operating lease obligations), along with its declining revenue and widening losses, make it a tough stock to own.

Investors who are looking for a long-term turnaround play are likely better off looking elsewhere.