Even though SFIX has bounced off its low of its low of 17.98 from Tuesday, I still think buying here is a great opportunity.
The stock justifiably ran up to over 30 shortly after reporting a great Q3 earnings result in June. Their revenue growth accelerated to 29.1% compared to 25.1% in Q2 and 23.9% in Q1. In addition, their Q4 guidance calls for revenue growth of 34-37%. If history repeats itself, revenue growth will beat the high end as management guidance is typically conservative. So in summary over the last four quarters, we are seeing revenue growth accelerate sequentially from 23.9% to 25.1% to 29.1% to 34-37%. Not only is revenue growth accelerating, but it is doing so at an accelerating pace.
They are growing at this accelerated pace while also being cash flow positive and profitable. They also have decent gross margins of 45.1%, which compares to 43.6% last year. In addition, it is their fifth consecutive quarter of YoY gross margin improvement. Despite an unusually large marketing expense in Q3 related to the UK launch, they still earned 7 cents per share even considering stock based comp (SBC). Most software companies are break even at best and this is after taking out SBC.
Also, they continually get better at what they do. As they sell to more clients, they get more data which then improves the overall experience and their ability to better target new customers. A big driver is launching into new markets. They expanded into mens clothing and have been very successful. They are using these lessons to successfully launch kids and into the UK market. The revenue growth is also coming from their current customers as the net revenue per client increased by 7.7%. This is evidence that their approach is working and this approach can be leveraged in many markets. There is a lot of opportunity to grow revenue with just their existing customers, but the real growth comes from new customers where they are doing well in their current markets and going into new markets. Many people like restaurants like Shake Shack because of their opportunity to expand from their small footprint by opening new stores. SFIX is doing this right now by expanding their markets (kids, UK) except they don’t have the same fixed costs as brick and mortar companies. Beyond the UK, the EU is an obvious next step and huge opportunity.
In addition to growing into new markets and increasing revenue per customer, I do think they are slowly becoming more mainstream. This is evident by Amazon, Gap and others jumping into the online clothing delivery market. By them doing so, it actually helps educate potential customers that this is becoming the norm. This can also be seen by the fact that revenue is accelerating.
In terms of valuation, SFIX currently trades at a market cap of $1.9B and considering they have no debt and around $250M of cash, the enterprise value (EV) is $1.65B. For a tech company growing revenue at 34-37% and annualized run rate revenue of $1.7B (based on Q4 revenue guidance of $425-435M), they trade at an EV/Sales of less than 1. For a software/AI company that is downright cheap if you compare to the SaaS highfliers (OKTA, ZS, AYX, ZM, CRWD, etc). Obviously we can’t seriously compare SFIX to these SaaS names but SFIX does have accelerating revenue growth and improving margins. Looking back at the stock history, SFIX IPO’d at 15.5 in 2017 and ran up to 52 in late 2018. During the December stock market slump where the market went down around 20% from the peak, SFIX hit a low of 16. It recovered twice to over 30 after both recent earnings announcements. The stock was back down to 18 on Tuesday and is up to 19 today. This is a volatile stock, but if you buy low, the stock can run up quickly.
So now let’s look at the reason for their depressed valuation. The biggest factor is that at the end of July, Amazon announced Personal Shopper by Prime Wardrobe, a styling service exclusively for Prime members. This is very similar to SFIX in that they use a personal stylist combined with AI. When Amazon starts competing directly with you it is obviously scary. On a positive side, it does validate the view that this is a growing market and Amazon’s entrance into it will likely get more people familiar with the concept. Amazon is obviously a huge threat, but that does not spell doom for SFIX. SFIX has a very focused CEO and team experimenting and improving their process which can be reflected in the revenue growth. SFIX has a big lead and has been doing this for a while and knows what works. Their data and experience give them a big advantage over Amazon. Also, Amazon is not as laser focused as Katrina Lake as Amazon tries many businesses. Recently they tried food delivery but then gave up as they could not compete against the incumbent players. Also, Best Buy was thought to be in trouble, but with their focus on electronics, they have performed well and their stock has more than doubled since the beginning of 2016. Amazon has also been competing with Mercadolibre in both Mexico and Brazil, but that hasn’t stopped MELI from growing strongly in both markets. This is a big and expanding market, so there is room for more multiple players, but I don’t see Amazon as focused as SFIX. I think Amazon is more likely to just buy SFIX then to compete successfully against them.
Another concern is the trade war and the tariffs, with the recent tariffs that went into effect as of September more directly impacting clothing coming from China. This was covered in their recent earnings call by Paul Yee, the CFO:
Hi, Eric, this is Paul. Thanks for your question. I think the first thing to note on tariffs is all of the tariffs enacted to date have had a very minimal impact to our business. So in essence our guidance does reflect any impact of tariffs in place today. And that being said, as you are aware, we are monitoring the situation very carefully where there is the potential for the remaining imports from China to be subject to tariffs. And like a lot of other apparel retailers we do source product from China. And should that situation arise we have three levers in our toolkit to manage that impact.
First and foremost, we have a very strong set of relationships with our brand partners and so we’re already starting our conversations to contemplate that situation, and ultimately how do we read our costs throughout our supply chain to mitigate any costs that come our way. Second, with our Exclusive Brands what we do on the supply chain, we’re already in the process of diversifying our country of origin and migrating some production from China to other countries.
And then finally, you alluded to this, one advantage that we have is, we do have a really rich data set of understanding our clients and their behaviors and response to any kind of changes. And so should we have to surgically pass on costs, we do have I think a good capability to do so. So there are a lot of unknowns that as you can imagine that we’re very much monitoring and managing scenarios and we’ll obviously give more updates as the news transpires.
Obviously, the tariffs will negatively impact SFIX, but it’s not a huge deal. They are looking into non-China vendors and given that they sell high-end clothing, they should be able to pass on much of the tariff impact. The average customer spends $467 per year, so we are not talking about budget shoppers who will balk at a price increase. Also, any trade deal should be a positive catalyst for the stock (up 3% on news of the October meeting announced last night).
Earnings are on 10/1 and I expect SFIX to do very well. They forecasted 34-37% Q4 revenue growth which compares to 21.4% in Q1. Each of the last 2 earnings, the stock popped significantly (20% plus), which was helped by the large short interest. After the last ER, may analysts raised their price targets to the high 30s. With the price now at 19, expectations are very low and overestimate the impact of Amazon and the trade war. I would actually be surprised if the stock does not pop on the 10/1 earnings.
I have avoided SFIX even though Tom G has been a big fan of the company. I am definitely not the target audience but looking at the numbers and valuation, I have changed my view. I think with the accelerating growth and improving margins combined with a very cheap stock price, we are looking at what Buffett would call a fat pitch. As such, on Tuesday when SFIX was trading between 18 and 18.45, I loaded up on SFIX call options.
Below is further reading/viewing which I highly recommend:
See Q3 earnings transcript here: https://seekingalpha.com/article/4268589-stitch-fix-inc-s-sf…
See Q3 shareholder letter here: https://investors.stitchfix.com/static-files/dbfc1359-c683-4…
See Katrina Lake discuss the company and strategy here: https://fortune.com/2019/07/15/stitch-fix-is-testing-new-way…
