Stitch Fix ($SFIX)

Personalized e-commerce

I hate shopping for clothes!  

I still want to have good clothes and dress well. But I hate shopping for them. I hate everything about it. The endless scrolling of e-commerce websites (or flipping through clothes in a store, depending on your preference), the disappointments of failed purchases, the hassles of the returns process, and the inevitable doom of repeating the same cycle. 

I would happily pay someone to shop for me. So you can imagine my excitement when I came to know of Stitch Fix, a service that takes the decision making away from buying clothes.

Key Stats

  • TTM (trailing 12 months) Revenue: $1.7B

  • TTM Gross Margin: 43.8%

  • TTM EBITDA Margin: -0.1%

  • Revenue Growth (3 Yr CAGR): 22.6%

  • # Customers (Quarter ending Jul’20): 3.4M

  • Avg. revenue per customer (Quarter ending Jul’20): $498

  • Net Debt: (-) $76M (means they have more cash than debt)

Things I like

1) Unique personalization model (using data science and human stylists)

Stitch Fix has a unique approach to personalized e-commerce.

They use a large number of data scientists (130+) to build models that can predict clothes/shoes/accessories that customers will like, based on many different types of data points shared by customers during signup.

The recommendations from the model are further augmented by the expertise of the company’s (5100+) stylists. This results in a set of recommended clothes (the company calls them “fixes”), which is then shipped to ­customers. Customers can either keep or reject these clothes – this feedback further informs their model – hence creating a feedback loop to improve the overall personalization process. According to the company, 80% of their shipments have resulted in customer feedback, which is a testament to how invested customers feel in their service.

The result of Stitch Fix’s unique model can be seen in the consistent increase in Net Revenue per Client over the years, as seen in the chart below (estimated from the company’s quarterly reports.)

I believe building a data-driven understanding of your customers take a long time and can’t easily be replicated by competitors. This gives Stitch Fix a head start as they have the data for 3.4M+ customers, collected over the last 9 years of its operations.

They do a good job of explaining how data-driven models form a core of their business. I encourage those interested, to visit this link: Stitch Fix Algorithms Tour

2) Accelerating growth through “Direct Buy”

Historically, Stitch Fix has limited its growth by being a subscription service where new users first have to go through the process of getting a fix. Not every customer likes to shop that way. This has resulted in slowing down the growth of new customers over the years (see chart below – estimated from the company’s quarterly reports.)

However, now that the company has built an extensive understanding of what shoppers like, it is now allowing even new customers to shop directly without going through the traditional, getting a “fix” process. I believe this business model significantly enlarges their addressable base.

The initial adoption of this service has been promising.

Stitch fix rolled this service to existing customers and adoption has increased from 5% in Feb to 13% in May (Source)

If the company can get this new service right, at scale (and there is no reason it shouldn’t), it can accelerate new user growth dramatically over the coming quarters/years.

3) Benefiting from COVID-related surge in e-commerce

Apparel retail is a difficult industry and COVID-19 related issues have driven many retailers to bankruptcy. Notable names include the likes of JC Crew, Brooks Brothers, Neiman Marcus.

Going forward, brick and mortar retailers will continue to struggle as more and more shopping shifts online. I believe Stitch Fix is in a unique position to benefit from this accelerated market share growth opportunity.

In the last earnings call, CEO Katrina Lake called it “a huge market share capture opportunity”. Here is president Elizabeth Spaulding’s take expanding further: 

With the major dislocation we are seeing right now in retail, we have the opportunity to dramatically accelerate share shift to Stitch Fix. We believe that more than $30 billion [of overall sales in the retail market] will rapidly shift online, which is 3 times what we would typically see in one year.

The latest SimilarWeb traffic data reveals an almost +26% increase in traffic in the last 5 months. This points towards a positive trend for the company and expectedly accelerating customer growth.

4) Headroom to grow in different categories, as well as geographically

Stitch fix primarily started for Women’s apparel in 2011 and only introduced shopping for Men in late 2016 and for Kids in 2018. I believe they have plenty of headroom to grow in these categories and there is a lot of time before they hit saturation.

Additionally, e-commerce is an expanding category globally and the company has expansion opportunities in UK/ Europe in the near future. (They introduced their service in the UK last year.)

Things I don’t like

1) Return to growth

Stitch Fix didn’t do well last quarter when revenue declined 9% YoY. Most of it was attributed to disruptions in the supply chain and warehouse closure.

CEO Katrina Lake noted on the Q3 earnings call that:

excluding the impact of our warehouse disruptions from COVID, we believe that we would have generated positive year-over-year net revenue growth in Q3.

The Q4 earnings call (Sept 22, AMC) will be important to understand if the supply chain issues have been resolved and if the company is able to service its demand well. Overall, both the customer growth numbers and the increase in APRU will be important metrics to look for. If the company can show a return to growth, it can also lead to a return of confidence amongst investors

2) Margin Improvement

Stitch Fix has shown profitable quarters in the past, albeit at a very low margin. The company has a stated goal to achieve ~10% net margin, primarily through a reduction in SG/A expenses as a % of revenue. It remains to be seen if Stitch Fix is able to demonstrate margin expansion in the future.

Final Take

Given the quality of the company and its unique model, I like Stitch Fix as a long term bet. While there are near term economic headwinds, the company is well-capitalized to survive through this difficult period.

The stock has made a run in the recent few weeks but is still substantially lower than its all-time high. At ~1.7 EV/Sales (TTM), it is not very expensive but investors are waiting for the company to show a return to growth and a path towards higher margin. If it happens, I believe we can see multiple expansion.

Disclaimer: I have a currently active long stock position in Stitch Fix

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