It's been a wild ride for the popular styling service and its shareholders. After posting steady growth in recent years, Stitch Fix (SFIX 0.47%) started to bleed clients last year, which coincided with rising inflation, interest rates, and the sell-off in stocks. The latest financial results still show the business struggling to find its footing, with revenue down 20% year over year.
Nonetheless, the stock price jumped about 30% following the report last week. The company demonstrated great progress in shoring up profitability and reported positive free cash flow of $21 million, but company guidance calls for another steep decline in revenue next quarter.
While it was a great sign to see the business return to positive free cash flow, I don't think that's why the stock was soaring following the earnings news. The real reason the stock is soaring is that Stitch Fix could be viewed as an under-the-radar play on artificial intelligence (AI) in the apparel industry. Here's why.
Stitch Fix is a cheap stock ahead of its AI opportunity
AI is taking over the global economy, it seems, and this could give Stitch Fix a second wind. The AI fever on Wall Street means market participants are scanning the dustbins looking for value alternatives to high-flying AI tech stocks like Nvidia. Stitch Fix, which uses AI and data science to power its recommendation system, might fit the bill. The stock trades at a market cap of just $550 million against $1.7 billion in annual revenue, which is a very cheap price-to-sales valuation.
Stitch Fix has had some execution issues lately, especially in the rollout of its Freestyle service, which allows customers to pick and choose items on their own -- all curated by Stitch Fix's AI-powered recommendation engine -- without the help of a human stylist. After a disappointing year, founder Katrina Lake returned as CEO in January to help turn the business around financially, and she will serve until a permanent replacement is found.
The steady decline in revenue over the last year presents a dilemma for investors. This is certainly not a recession-resistant business, but the company counterbalances that vulnerability by keeping plenty of cash on its balance sheet with no debt.
So why hasn't the company gotten off the ground yet? I think it might just be a business ahead of its time. Most consumers either aren't aware of these types of styling services or just prefer shopping on their own. However, as AI becomes more embedded in everyday life, the market for these services could explode.
Has Stitch Fix stock bottomed?
The company is starting to use AI to optimize inventory. Using this new tool, Stitch Fix can better predict customer demand and proactively make smarter inventory-buying decisions. This could go a long way to better matching supply with demand and lowering costs, and therefore bolster the company's profit opportunity.
With all the advantages Stitch Fix has with data science, AI is not going to grow revenue on its own. The company is preparing for further weak economic conditions by considering the pullout of its business operations in the U.K. Management is also reducing its distribution network to three fulfillment centers in the U.S., saving an estimated $15 million in costs.
Still, I believe Stitch Fix's stock performance over the last year more than compensates investors for near-term macroeconomic risks. The risk-to-reward ratio at these levels is attractive, to say the least. You won't find many tech-savvy companies using AI trading at a low price-to-sales ratio of just 0.3.
While there are many personalized styling services out there, none offer a sophisticated shopping experience and an easy-to-use dedicated mobile app like Stitch Fix. Almost every "best of" list will have Stitch Fix ranked as the overall best-personalized styling service. It's by far the leader in this market.
The appeal of AI to the consumer is that it saves time browsing for items online. That's precisely the future Stitch Fix has spent the last decade building. The choppy financial results over the previous five years might just be a warmup for what's to come over the next decade.
It definitely appears to be a business ahead of its time that might find tremendous success once inflation disappears. The recent lows just might be as cheap as the stock ever gets.
