Stitch Fix: A Profitable Investment

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SFIX Logo

Introduction:

Since 2006, the following department stores have decreased in value by: 99% Sears (SHLD), 93% J.C. Penney (JCP), 66% Macy’s (M), 53% Kohl’s (KSS), 35% Nordstrom (JWN), and 31% Dillard’s (DDS). In relation with these stores, Amazon (AMZN) has dominated retail and devastated the competitors listed above. So, what would happen if someone took Amazon-like e-commerce to the clothing industry? Well, Katrina Lake had that idea and transformed it into a company called Stitch Fix (SFIX). As stated in their mission,

“To change the way people find clothes they love by combining technology with the personal touch of seasoned style experts. The Stitch Fix experience is not merely curated – it’s truly personalized to you. We’re here to help you save time, look great and evolve your personal style over time.”

Department Stores Market Caps Stitch Fix started in 2011 and has gained popularity following their rapid success. The company went public recently, last November, and has caught the attention of some small cap investors, including myself. So I decided to dive deeper into the company, figuring out what kind of investment SFIX really is.

Overview/Business Structure:

Stitch Fix is a subscription-based personal shopping and delivery service for women’s and men’s clothing. It offers services that deliver customized outfits tailored to each individuals style directly to doors all across the U.S. The process for customers is rather easy as it took me about 15 minutes to get through. The process consists of creating an account, going through your personal style, selecting the brands you wear, choosing specific outfits you like, and providing some personal items like height, weight, clothing sizes, etc. Following the detailed clothing quiz, the answers are put into algorithms that produce your style and connect you with a personal assistant to aid you through the shopping process. So in summary, online shopping on steroids.

SFIX Process

Subscriptions are optional, and you can choose the pattern of the subscription. Each clothing package sent to your door is called a “Fix” and comes with a $20 “styling” fee that can later be credited back if you decide to buy one or more of the five items sent with the Fix. And if you chose to go with all five items, you receive a 25% discount. The subscriptions are based on how often you would like to receive a Fix. Typically, customers will decide to go with a few Fixes per month, delivered automatically. But one can also manually order Fixes on their own time and receive them with no pattern and at their own convenience. Each clothing item, on average, cost around $55 but obviously fluctuates on both the high and low end of the average. And in 2016, the average revenue per client (on an annual basis) was around $500 alongside 2.7M active clients.

Stitch Fix specializes in women’s clothing, as they originally started this service for them but also provide services for men that was started roughly two years ago. And as of recently (June 7th), they have announced a new kids line for customers which seems to be timed perfectly as a new wave of “back to school” shoppers will appear come August. This new addition seems to speak into CEO Katrina Lake’s “scalable” philosophy as they already have clothing for petite, plus-size, and maternity selections for customers. And with a new kids line addition, Stitch Fix will be able to provide for the entire family, no matter the make or model.

Management:

Katrina Lake founded Stitch Fix in 2011 and has been with the company since. She has surrounded herself with what seems to be an impactful leadership team as the company has generated a 70.63% return* to shareholders since the IPO last November. In comparison to the S&P 500, the SPY has generated roughly a 7.45% return*, a tenfold difference compared to SFIX. Granted, the return could be explained by the investors’ overconfidence in the business structure but taking a deeper look into their earnings seems to override that objection. Q3’18 delivered net revenue of $316.7M, showing 29.2% YoY top-line growth as well as net income of $9.5M, representing 3.00% YoY bottom-line growth. Management has also recognized their need for expansion, as in their most recent letter to shareholders they stated,

“We remained focused on expanding our total addressable market. In February, we celebrated the one-year anniversary of our Plus-sized offering. And today, we’re excited to announce the upcoming launch of Stitch Fix Kids.”

SFIX Q3

* Based on increase in share price and numbers taken from Seeking Alpha

Numbers:

The company is currently trading over 200 times earnings with no dividend and an EPS of $0.11 per share (with estimates to increase by $0.19 at the end of FY 2018). The dividend is obviously no surprise as management continues to invest profits back into the company to help fund their organic growth. And price to earnings does not represent a useful metric as the company is still experiencing rapid growth and little profitability. However, price to sales, a more effective measure of value, shows a ratio hovering around 2.5 when the industry average is 31% higher at 3.3 (industry peers shown below). Their market cap is 2.6B, while EV is 2.0B. And one of the most attractive features of SFIX is they currently have zero debt, both long-term and short-term. ROA is 4.00%, and ROE is currently 8.69%, again recognizing the success of management’s investments. And lastly, cash & short-term investments represent $287.26M as of April and has increased every year for the past 5 years, showing signs of an improving balance sheet.

SFIX Industry Peers * Numbers taken from Q3’18 Earnings Report and picture taken from Morningstar

Buy or Sell:

Buy, SFIX is currently a valuable company to own and moving forward will only become more beneficial for investors to profit from. Here’s why…

The announcement of their kids line, which markets children aged 2-14, will add great value for the company going into August. Their recent success with previous product line additions warrants the profitability their kids line will experience. Most active users, over half actually, already have children according to Katrina, and each kids item will range from $12-35. And although less expensive than adult Fixes, each kids Fix will range from 8-12 items, compared to the 5 items in adult Fixes. This new line for kids, along with the others added in the past, have been able to boost earnings for the company without adding any additional debt.

Katrina Lake also announced two other additions in the company’s last earnings call. The first is called “Style Pass”. Style Pass allows customers to receive and return Fixes with less “friction”. Assuming friction is synonymous with issues, I’m guessing management is making the process for customers much more easier to cycle through Fixes. The profitability from this service will come from client retention which I’ll cover in the next paragraph. And regardless of the meaning, enrollment for this service has exceeded management’s expectations for both men and women. The second service is called “Extras”. Extras adds even more value for customers by allowing them to add more items like socks and other accessories to each Fix they order. So, basically, the company is looking at ways to ship Fixes with more than five items at a time i.e. more profit. These additions and expansions will serve the company well. Last year, SFIX experienced a 30% increase in active users (2.7M) and as a result, they have been leverage the growth through internal expansions.

As the company continues to grow their client base, they are also retaining existing clients through a variety of different methods. The first being a program called “Style Shuffle”, which is an interactive mobile and web-based game allowing users to rate certain Stitch Fix merchandise. The game allows clients to share feedback with the company to help them better understand clients personal style and tailor it accordingly. This service has had very positive feedback as Mike Smith, the COO said, “While early in Style Shuffle’s implementation, we’re seeing higher client engagement and satisfaction among the clients that use this gain.” And the previously mentioned Style Pass feature shows the ease of access customers experience, motivating them to use SFIX again. The more simple, the better. Style Pass also shows the willingness management has to listen to their customers and adjusting to their preferences.

Competitive Advantage:

One of most powerful competitive advantages SFIX has is their ability to do everything digitally. There is no need for massive rent expenses for every store location and unlike the companies listed in my introduction, Stitch Fix is able to limit costs and increase profits this way.

Each customer is assigned a personal assistant to help with your style and at no cost for the client. Customers no longer have to spend time figuring out their style and determine which brands and stores work the best for them. They simply tell the clothing assistant their style and then receive various options to choose from in return. And even if they don’t know their style, the assistant works with them to figure it out. Again, I have never found myself walking into any of the stores listed in my introduction that connects me with an assistant to help chose my style and which clothes to try on.

Another important advantage under the same digital influence is the Stitch Fix shopping process. Traditional shopping forces customers to either travel to each retail store individually or purchase items online from each retail store individually. On top of that, if you purchase the clothes digitally without trying them on and you don’t end up liking them, then you’re forced to go through the return process which wastes even more of your time. Stitch Fix simplifies the shopping process making it easier for customers. As I mentioned in the overview, SFIX shoppers are sent items selected by their stylist in which the liking of the options received are determined in the comfort of their own home. Nothing is purchased beforehand (besides the cost of the Fix that can later be credited) so returning items is no longer a difficult process for customers.

Conclusion:

Stitch Fix has evolved the shopping process for consumers by utilizing advancing technology and e-commerce to their benefit. The company continues to impress investors and management is constantly looking at ways to improve the business. The financials of the company show profitability is starting to sprout, and investors should be excited to ride the bull heading into the future.

Disclosure: I am/we are long SFIX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.