Between its initial public offering in late 2018 to its peak in early 2021, Farfetch (FTCH +0.00%) saw its shares soar 158%, as investor enthusiasm reached ever-increasing levels. The surging stock price is understandable given the innovative and disruptive potential with this business.
What goes up, must come down, however, and Farfetch's shares are down a whopping 94% as of March 24 from their all-time high of $73.75 set in February 2021. Is it time to be opportunistic and buy this apparel stock? Let's look at the pros and cons to answer that question.
OTC: FTCH
Key Data Points
Farfetch has some positive traits
Probably the single most favorable characteristic about Farfetch is that it is a platform and marketplace business that focuses solely on luxury goods. As far as online shopping is concerned, luxury items still have a long way to go. According to Statista, luxury goods are set to increase their e-commerce penetration to 25% in 2025, up from just 10% in 2018. As a leader in the space, this trend bodes well for the company's long-term prospects.
Farfetch has experienced outsize growth, with revenue increasing at a compound annual rate of 43.1% between 2017 and 2022. This type of gain wouldn't be possible unless the business was providing a compelling value proposition to its stakeholders. Brands and designers gain access to shoppers from more than 190 countries. And customers can browse a truly global product offering, with items from more than 50 countries and 1,400 brands and shops. Farfetch was able to grow its active customer base by 6.3% last year, despite elevated inflation.
The management team is optimistic about 2023, too, as they forecast gross merchandise value (GMV) of $4.9 billion, up 21% year over year. Wall Street expects revenue to jump 18.5% this year.
Besides operating an innovative business model that has demonstrated tremendous growth over the last few years, Farfetch is also trading at a rock-bottom valuation. As of this writing, the stock is selling at a price-to-sales multiple of less than 0.9. The current valuation is about as cheap as shares have ever traded for, meaning investors have completely soured on the business, demonstrating full-blown pessimism with Farfetch's prospects.
"Be greedy when others are fearful," as Warren Buffett is famously known for saying. For investors who still believe in this company and the direction it's heading in, now looks to be one of the best times to add the stock to your portfolio, as the upside potential is really massive if Farfetch can successfully execute.
Farfetch still faces challenges
On the other hand, it's not all gravy with this business. Shutting down operations in Russia because of the Ukraine war, and pandemic-related restrictions in China, were major headwinds last year. Being a global company has its advantages, like avoiding geographic concentration and attracting a broad base of users, but the strong dollar also seriously hurt Farfetch's financial results in 2022.
This backdrop helps explain why 2022 GMV of $4.1 billion was down 4.1% year over year, with revenue rising only 2.7% in 2022, a dramatic slowdown from previous years. What's more, softer demand has resulted in an uncomfortably high inventory balance, a problem management said needs to be fixed with more markdowns, which will pressure margins in the near term. And if the world enters a full-blown recession this year, it's a wonder how resilient demand for luxury items might be when customers have less discretionary income to spend on expensive goods.
The uncertain macroeconomic picture doesn't help Farfetch's unfavorable financial situation. Yes, this company has increased its sales at a rapid clip over the years. But what hasn't shown any improvement is profitability. While Farfetch's top line expanded 1,528% between 2015 and 2022, the gross margin has actually compressed. And even at its current scale, which is obviously much bigger than years ago, Farfetch's operating margin hasn't even come close to turning positive. Investors need to ask when, if at all, this can become a profitable enterprise.
I also have to ask how much negotiating leverage Farfetch has with some of the most prominent brands, like Hermes, Gucci, and Prada, to name a few. I think these brands need Farfetch's distribution and awareness capabilities far less than the business needs the brands on its platform to drive traffic and attract buyers. This could dampen Farfetch's ability to monetize its marketplace down the road.
These negative attributes, particularly around the lack of consistent positive net income, severely outweigh the positive traits when it comes to Farfetch, in my opinion, making it obvious that owning the company is a very risky bet. And for that reason, I think investors are better off passing on this stock for now, no matter how enticing the cheap valuation might be.
