M - Stitch Fix: Priced For Disaster

2023-06-07 15:34:06 ET

Summary

• Stitch Fix, Inc. reported mixed FQ3 numbers, though the company did beat expectations.
• The online personalized shopping service was cash flow positive despite the revenue dip.
• Stitch Fix stock is cheap, trading at only 0.1x EV/S targets, a big discount to department stores.

Stitch Fix, Inc. ( SFIX ) continues to struggle to turn around the business following covid pull-forwards while facing macro headwinds. The company already uses data science and AI to help personalized stylist selections for customers, providing a quick path to implement any new AI technologies. My investment thesis remains ultra Bullish on the stock, which is trading as if the company is headed towards a disaster while Stitch Fix has solid financials.

Struggles Persist

Stitch Fix definitely reported a mixed FQ3'23 quarterly earnings report as follows:

Sure, the online personalized shopping service beat analysts' estimates, but Stitch Fix reported a nearly 20% dip in revenues. The company topped $400 million in FQ3 revenues back in 2019 prior to covid, in an example of how far the business has fallen back to earth following a sizable bump when consumers were only shopping online.

The key here is that Stitch Fix has a roughly $1.6 billion business (prior to exiting the UK) with minor adjusted EBITDA profits. The financials of the company are solid, with Stitch Fix actually producing nearly $22 million in free cash flow for the April quarter and $37 million in operating cash flow YTD.

The UK business is holding back profits with a $15 million adjusted EBITDA loss on only $50 million in annual revenues. The company could quickly boost profits and cash flows by just focusing on the U.S. market and exiting this foreign market that hasn't scaled.

In essence, Stitch Fix has a stabilizing business with positive cash flows. The key is for founding CEO Katrina Lake to build on the base business from here.

The company has cut the advertising expenses to 7% of revenues, down from 12% last year, in order to improve profits. The company used to spend ~10% of revenues on advertising, leading to a savings of nearly $40 million in the last quarter alone.

Stitch Fix reported an adjusted EBITDA profit of $10 million for FQ3, beating guidance for nearly flat numbers. The majority of the adjusted numbers are stock-based compensation ("SBC") and depreciation costs. In fact, the adjusted EBITDA measure actually removes nearly $2 million in interest income that would normally be included in a non-GAAP profit measure.

Priced Like A Department Store

Entering FQ3 earnings, Stitch Fix had a market cap of slightly above $400. The company has a cash balance of $244 million, leaving an enterprise value of only ~$150 million.

The stock valuation is amazing considering the revenue base in the $1.6 billion range. The company is struggling due to market conditions, but Stitch Fix still offers the opportunity to work with data scientists - and now AI - to sell apparel at attractive gross margins in the 50% range.

While Stitch Fix has struggled, the stock now trades at forward EV/S multiples far below those of beaten down department stores. Stitch Fix trades at only 0.1x forward sales targets while Macy's ( M ) and Nordstrom ( JWN ) trade at triple the EV/S multiple at 0.3x.

Considering the data scientists and personalized styling service offered by Stitch Fix, the goal shouldn't be to trade at just a department store multiple. The stock should obtain a premium valuation multiple, especially once the company returns to growth mode following this difficult period and the likely exit of the money-losing U.K. business.

The FQ4 guidance won't help with a sequential revenue decline. Stitch Fix is guiding to revenues of ~$370 million, but the company is targeting an adjusted EBITDA profit ~$5 million above the original FQ3 target.

The market will like this offset of higher adjusted profits over revenue growth. Of course, the biggest issue is that Stitch Fix continues to trade at new lows due to concerns about business prospects and the ultimate best solution is to return to profitable revenue growth.

Takeaway

The key investor takeaway is that Stitch Fix, Inc. stock is crazy cheap trading at cheaper valuation multiple than struggling department stores. Investors should use the weakness to load up on the stock.

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