Is Farfetch a Deep Value Stock or a Falling Knife?

Farfetch's (FTCH -2.22%) stock sank by 45% on Friday after the luxury e-tailer posted its second-quarter earnings report. Its revenue declined 1% year over year to $572 million, missing analysts' consensus estimate by $79 million.

Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) loss widened from $24 million a year ago to $31 million, but its adjusted loss of $0.21 per share still cleared the consensus forecast by $0.02 per share. Those numbers look dismal, but could Farfetch -- which now trades at a nearly 90% discount to its IPO price -- actually be a deep-value stock for daring investors? Or is it a falling knife that should be avoided at all costs?

Image source: Getty Images.

Why did Farfetch's stock collapse?

Farfetch's U.K.-based online marketplace features nearly 1,300 luxury brands and connects sellers in over 50 countries to buyers in more than 190 countries. It also owns the London-based retailer Browns, the New York-based sneaker and streetwear reseller Stadium Goods, and the Milan-based streetwear maker New Guards Group.

Last year, Farfetch generated 61% of its revenue from its digital platform services segment, which includes its commissions from third-party sales and direct revenue from first-party sales. Another 14% of its revenue came from its digital platform fulfillment division, which generates most of its revenue from delivery fees.

Its brand platform division, which distributes its products to third-party retailers, generated 21% of overall revenue. The remaining 4% came from its brick-and-mortar stores. However, the growth rates of all four of those core businesses slowed down significantly in 2022 and only slightly recovered in the first half of 2023.

Data source: Farfetch. YOY = Year over year.

Farfetch's growth decelerated last year as inflation, currency exchange headwinds, the Russian invasion of Ukraine, and China's strict COVID-19 lockdowns curbed its online sales of luxury goods. Its e-commerce sales warmed up again in the first half of 2023 as inflation receded in the U.S. and China ended its zero-COVID policy.

Unfortunately, Farfetch's brand platform revenue plunged in the second quarter as macroeconomic headwinds drove many third-party retailers to reduce the amount of new inventory they were taking on. Those challenges are also throttling its first-party brick-and-mortar sales. In other words, Farfetch's gradual expansion into the brick-and-mortar market over the past eight years backfired, and its declines offset the steadier recovery of its online business.

A dim outlook for the rest of the year

Farfetch expects its ailing brand platform business to recover somewhat in the third quarter, but its near-term outlook is still grim. Management expects its total gross merchandise volume (GMV) -- i.e., the value of all of the goods sold on its platform -- to rise by only 7% for the full year. It expects digital platform GMV to grow by 10% but anticipates that brand platform GMV will be flat.

That overall result would be an improvement from Farfetch's 4% total GMV decline in 2022, but it's also much weaker than its prior forecast for 20% GMV growth. Some of that slowdown can be attributed to macroeconomic headwinds, but competition from other online marketplaces and direct sales from luxury brands could be exacerbating matters.

Farfetch is also tiny compared to the major online marketplaces. Its number of active consumers rose just 7% year over year to 4.1 million in the second quarter, while its average order value (AOV) shrank 6% to $561. That AOV suggests that Farfetch mainly sells "affordable luxury" brands -- which are more exposed to inflation pressure than higher-end, recession-resistant brands like those owned by LVMH and Hermès.

Farfetch lacks a clear path toward profitability

Management claims Farfetch can achieve a positive adjusted EBITDA margin of 1% this year, compared to negative 5% in 2022, as its free cash flow turns positive. Those might seem like baby steps in the right direction, but Farfetch still racked up a staggering net loss of $500 million on a GAAP (generally accepted accounting principles) basis on $1.13 billion in revenue in the first half of 2023.

The amount of cash and cash equivalents it had on the books dropped from $734 million at the end of 2022 to $454 million at the end of the second quarter, and its high debt-to-equity ratio of 6.3 could limit its ability to raise more funds. Nevertheless, it still expects a recent expansion of its loan facility to boost its cash and equivalents back to at least $800 million by the end of 2023.

Farfetch won't go bankrupt anytime soon, but its sluggish growth, steep losses, high leverage, and unstable liquidity should prevent the bulls from rushing back while the current challenging macro environment persists. That's why this stock is a falling knife -- even if it seems like a deep value play at 0.4 times this year's sales.