Chit Chat Stocks - Fundamental Analysis: Stitch Fix (SFIX)

Episode Date: September 27, 2020

On this episode, Ryan and Brett discuss the online styling service Stitch Fix. They start out going through the history of the company and some fundamentals for the stock (0:30). Then, in the second half of the show, they give their analysis on any competitive advantages and future growth opportunities the business might have (8:00). To finish-up, the pair discusses what they like and dislike about Stitch Fix (15:00).  --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome in, everyone. This is the Fundamental Analysis Show on Chit Chat Money, where we discuss a single stock and go over everything that they do. It is going to be about a 20-minute episode, different than the deep dive, if you just listened to that one. We're not going to have Ian on. It's just going to be Ryan and I, and we're going to go over a little less, but it's still a good overview of the company. Today, we're going to be talking about Stitch Fix. So, Ryan, do you want to get into what Stitch Fix does and the history of the stock and the company? It's a pretty common name now, so I would imagine a lot of people do know what they do, but Stitch Fix, if you don't know, is an online personal styling service, and they're headquartered in San Francisco.

They really burst onto the scene when they basically revolutionized traditional online retail, and so the concept that they developed, if you don't know, was that for a fixed fee, they would send you a box full of clothes. you'd pick from that box what you liked and you'd keep it anything you didn't like you'd send back and they'd charge you for what you kept um i mean that was sort of revolutionary at the time essentially they brought the dressing room to the customer and then to add to the customer value prop they use a recommendation algorithm and data science to curate a personalized fix for the customer so they personalize what they're sending to you and they're trying to basically optimize this algorithm so that you're getting the best clothes and you're over time buying more from that fix um while stitch fix doesn't have uh their well they do

have their own brands but a majority of the products they're offering come from other brands like north face j crew and there's more than a thousand other ones the company was started in 2011 by katrina lake and former j crew buyer aaron flynn the company got its start um styling for women specifically but they've expanded their operations out now to men children as well and the operations were based out of katrina's apartment when they first started oh what a they have the classic startup story where you kind of roll your eyes you know like yeah this totally matters for how stitch fix is going to do as a business right yeah and then in 2011 stitch fix got their first round of seed money from baseline ventures and they opened their first warehouse a

year later in san francisco and so i believe baseline ventures still owns like 46 of the voting shares or yes they've had they had trouble getting venture money which dilute you know i guess that helps where they don't have to dilute stuff if they still survived uh so yeah i would think that makes sense that baseline still has a big stake when you're strapped for cash and you're struggling to get venture money you're gonna end up as a venture firm getting better terms so stitch fix might have gotten screwed a little bit right right in that way um yeah and then also benchmark led their series b in 2013 stitch fix ipo'd in 2017 and as of 2019 katrina lake still owned 27 of the class b common stock and about 24 of the total voting power good that's actually i

like how they don't have dual class i was kind of worried about that happening but that is a large stake for sure 27 is huge i mean if they succeed that's that's huge unless they dilute further but i'll get into the valuation here the next section they have an enterprise value of 2.6 billion dollars and on the first show back i used market cap but we are and of our enterprise value podcast we like to have that instead uh and enterprise value is just adding in the net debt which is taking the debt and subtract or adding back the cash so they have 2.6 billion dollar enterprise value their ticker is s f i x price is 26 and 46 cents as of september 24th 2020 eb sales 1.56 they are not profitable but have been cash flow positive every year since exception

right around 20 to 40 million dollars in free cash for the last five years so not substantial they're right close to break even but it still is positive so they're probably not going to have to raise any follow-on financing gross margin for the last full year was 44 percent they currently have $254 million in working capital, current ratio 2.2. So the balance sheet looks fine, no concerns there at all. $140 million in lease liabilities that are only, that's their only long-term liabilities that are of any significance. So that's really no concern there, no long-term debt. And then share count went up about 2% last year. So it seems pretty standard, nothing concerning from that front. Yeah, relatively stable, but make sure to pay

attention to the per share metrics if uh if if you're looking at the share count there yep um i'll get into the earnings in the fourth quarter they had 443.4 million in revenue that was up 10.6 percent year over year they grew their active clients to 3.5 million that was up nine percent year over year and they delivered 42.8 million in operating cash flow operating cash flow is down 45 percent year over year they're not making as much money as they did last year the gross margins were basically stable jumped from 44 to 45 and then they had a net loss of 44 and a half million versus net income of 7 million last year 43.2 million of that net loss came from stitch fix recognizing a non-cash tax expense i believe this is singular in nature and i don't think it's going

to be recurring okay yeah that makes sense um i didn't know what they if they had any explanation on that but if it says non-cash tax expense typically i think they're just allocating stuff to future taxes so that's not going to happen every quarter and then they the advertising expense as a percentage of revenue grew from nine percent to ten percent not super meaningful they paid 213 million in sales general and administrative expenses that's 13 percent more than the prior year and then they had 143 million in cash and cash equivalents at the end of the quarter versus 170 million at the beginning of the period all in all not a great quarter and They just announced this quarter.

I think that was like three days ago, two days ago. I mean, any first thoughts there? Well, you can't have SG&A expenses growing faster than revenue forever. You would have to look at that and say, okay, if they're spending 13% on SG&A this quarter more, if that grew 13%, you would hope that revenue will grow faster in the quarters looking in the future. They did have some uncertainty with COVID. Their warehouse was shut down. They had extra expenses paying COVID relief for their workers, which I think is a good thing.

They did like four weeks of that, so that boosted that, and that should not be recurring. So hopefully their SG&A expenses won't be growing as quickly in 2021. It's a little tough to distinguish how much of this was COVID-related expenses versus customer acquisition costs just outright growing. So I would probably pay attention to advertising expense if you're looking for customer acquisition costs there. Yeah, that makes sense. All right, we're going to hit the ad break here. If you're watching us, which the few people that do watch us, we're just going to hit right into the second half.

We're going to hit the ad break, and then we're going to come back and talk about any competitive advantages, future growth opportunities, highlights and lowlights, and discuss whether we like or dislike Stitch Fix after doing the show going forward. you all right welcome back first up competitive advantages ryan do you want to go first any thoughts or any what topic did you choose yeah competitive advantages i i feel like the only real competitive advantage they have is the actionable data that that truly is for me

the only one i can think of because aside from that there i don't see a network effect there isn't a level of brand recognition that you'd find with say like a nike so it you know if you're walking down the street and you see the nike swoosh on a pair of shoes you automatically can say all right i know where to go buy that if i want to go buy that you're not going to do the same thing for whatever the market in spruce which is like stitch fixes brand like you're not going to know so i think people talk about the network effect i don't think that's a huge component i think they can leverage that data in a huge way and if if that's the bold thesis that's fine but i don't think it's a network effect yeah and it's not it's a network effect just like a department

store would be so if you do a comparison to nordstrom's nordstrom's worked because people trusted their stylists they trusted their curation uh for people to you know go into the store and like oh i like this stuff now people are hopefully going to go to stitch fix if you think they're gonna um if you think the business is going to succeed you would hope that people trust stitch fixes stylists and algorithms the combination of computers and personal stylists to pick the clothes for you and do it in an, you know, use the internet to make it a better business and a better value proposition for the customer and just, you know, save them time. But it's not like a network effect like Facebook where the more users equals a better product. That's really

not what's at play here. Yeah. What's your competitive advantage? So this is a potential one. I don't think it is locked in stone. So they spend millions and millions on R and D for this algorithm. They always brag about that. I don't really know if it's going to work out. So they need to continue growing the business and increase their margins and increase obviously average selling price churn stuff like that if they're going to get a strong return on invested capital but i think it kind of you know it's hard to disrupt that because you are spending a lot you do have to spend a lot a startup of three people like us really wouldn't be able to repeat that but i don't think it's impossible some other company could come in and do that you know what

realized we didn't put in our notes here is further reading oh right right what would you be looking into if you wanted to expand your research on this churn churn uh whether stitch fix works because anecdotally i've heard some negative stuff on that i would love to see their churn numbers i would love to see if they have a dedicated cohort of consumers because if they have a million dedicated customers i think there's some you know promise there but if they don't and it's just a ton of churn that's a negative sign to me yeah and i think so this is something that would be easy to figure out but for me i would be looking at how do they get their inventory are they buying it what's the relations like with their suppliers or those brands because that has

probably huge implications on the margins i'd imagine yeah definitely and that's just something i haven't looked into what about your future growth opportunities okay the direct buy is mine i'm pretty well it's a new uh initiative but i i like it a lot so it may end up being the more consumer-friendly option that just makes sense for stitch fix because i think they do get a little uptight with the fixes and focusing on that too much because i think it's a solid idea but i think there's a lot more they could do with this recommendation stuff and that sort of style and maybe span like a broader audience because not everyone wants fixes it's kind of a big leap to take that and you kind of have to say all right i want new clothes every six months or

two months or one month and not everyone is like that so in the earnings call or the earnings letter i forget which one it was they said is a critical option for our future which i like shows that they're going to be investing a lot of money into this in june of this year they launched the trending for you section and they said in the first two weeks after this launch direct buy grew 30 which is a big boost so it looks like that worked hopefully they continue having a strong growth right there although they're not going to grow 30 every two weeks but they also launched a new algorithm for direct buy in july and they said that the average selling price is higher right now on direct buy than their fixes which shows at least i think initially that my theory may be

correct that direct buy is the better option for stitch fix in the future yeah i would not be upset if they outright pivoted the business to a recommendation based direct buy offering primarily And that is – the fix concept is something that I like, but it's tough to do. And direct buys obviously has a lot of tailwinds behind it. I mean if people use fixes and they have 40% gross margins, why not? But I don't know if the growth is as high as people may think. So I don't know how much money they should invest into that. But I still think it's not dead obviously.

Yeah. If I were them, I would really hone in on the recommendation algorithm and it feels a little bit like – you know when you see the stories of Amazon in whatever it was, 1997, and they're like, yeah, so they would buy a book and then they'd get a recommendation of books you might also like. They can be that for retail and it really applies to the direct buy. And the other part is if the algorithm is really sound, it's going to lower overhead costs and it's going to expand margins because then you don't have to hire a personalized stylist to do it for you because that can be done by the algorithm. Yeah, and if we want to make it – so people may be confused by this comparison. So think Amazon disrupted the book market because they used that recommendation system and it made it easy. Within 30 seconds, you could see I can browse these more. that opened up the market for books to a ton more people outside of say the people that would go to

barnes and noble or another bookstore spend an hour perusing books in their free time kind of as a hobby and not everyone has that time not everyone has that time as well in the fashion industry to spend two hours at nordstrom not a lot of people like to do that if stitch fix can open that up and say for me or ryan or anyone else say save them a ton of time and start you can look at stuff you actually are like and you it's not something you do as a hobby i think that could open up the market for people to you know i don't i mean it just open up their market more and help if they can do that yeah what about highlights and lowlights okay last section here they showed this quarter the ability to quote skate where the puck is going i know that's cliche

but they had 30 350 growth in a woman's athleisure and it shows i think to me that the platform is good for just wherever apparel is going they don't have to just create the trends but they can follow where the trend is going which is why it's nice to have that partnership with all the other brands they can do that for them the other part that that leads me to believe is something that i feared about stitch fix is consumer tastes change and the ability to grow or skate where the puck is going that i mean they demonstrated that that it's not they're not going to fix you into one style like they're not gonna have a personalized style just and you can't get out of it yeah and it shows that this business may not be cyclical uh they're not dependent on uh trends cultural

changes economic stuff uh for the business to succeed what about low lights low lights um okay one more highlight i had though is them moving away from fixes like i just said and their balance sheet i think the balance sheet's great um 10 out of 10 for the balance sheet i don't know it seems very solid but low lights for me i don't think the investment investments in curation are going to return that much in the long run the stock's kind of priced like that so you may not need to have a super high roic to get good returns on your investment in the stock i think katrina lake although she seems very smart she does talk a lot in buzzwords and they talk a lot about data science machine learning ai for a retail business which you know it just seems like they're trying

to hype up the stock uh which i don't like and then competition is strong so someone like lulu or nike can possibly go d to c and undercut some of their market share that competition is strong and it's the reason why some of the department stores don't succeed or have very high margins is because someone like lulu lemon or nike will come in and just go direct to consumer and take all that margin yeah yeah i totally agree my i'll get into my highlights that the collection of data is super powerful and it's also super valuable and i believe it was austin lieberman i think who was the first one to say maybe they could leverage that and um outsource it or allow or license it to other companies to use yeah the point is that algorithm and the data ends up

being super valuable for them that's a huge highlight also the valuation is pretty good like if if they're right you're right big it's not like their success is priced in here there's not the it's i'd say i don't know what type of revenue growth it depends on their margin and stuff but yeah i'd say a pretty average future outlook is priced in like it's not like dirt cheap anymore it was dirt cheap in the spring but right now it's like yeah i mean if the business succeeds you could really have a you know 10 beggar here over the next decade and my low light is around the concept of the fixes and so i do like the concept but i think and i've said this before i think they might have a first mover disadvantage in this regard because they are

and according to an article from investopedia and i know you're not going to like this stat it costs approximately 60 to 75 percent less to replicate a product than it costs to create a new product i'm not saying someone can easily do it better because there's a lot of logistics framework and logistics infrastructure that it requires to do that but think tesla with the electric car just because they were the first one doesn't mean someone else can't do it they might have just built a gold mine for someone else to come and collect that's true um and you could argue like say okay amazon could come in invest a lot of money and copy this pretty easily but they've tried um and it sort of reminds me and i always make this comparison so i guess drink because i

made it spotify versus apple just because spotify is going up against larger competition it doesn't mean they have the brand now i think stitch fix does not have the brand value that spotify has so that is a higher risk um for churn and stuff like that but could they build it over time i think so but anecdotally and these are stats you probably want to research i don't even know how easy it would be to get it's probably hard uh statistics to get because they're not going to release this but the churn numbers things like that can kind of show if the brand isn't as high of quality among the consumers yeah all right we have a new wrap-up do you want to talk about it yeah so we're not doing the rating anymore just for uh disclosure purposes for

things we're doing um you know outside of the podcast so we're gonna just ask one more question here it's just gonna be are you more interested or less interested in stitch fix after today so after the research do we think we want to research it more at a tour watch list or are we just gonna say no you know what we're gonna let this sit on the sidelines and what do you think i'll say i'm more interested i think i was discounting the fact that they don't have a brand at all before this and i was like you know retail is something that's dominated by recognizability and relevance to an extent and it felt like stitch fix didn't have that but they are giving the customer options and i think leveraging the data to a stronger direct buy component of the business is the way

they should go i think that alone could be a 10 billion dollar business but i just i'm not totally sold on the fix but the the direct buy momentum is it's encouraging yeah that's my the biggest positive for me as well if they can keep the margins up with that that would be strong it looks like they're having some good indicators but that is early early innings for that um and i'm more interested as well i think yeah we're both interested in stitch fix but we have some red flags and concerns that we'll need to research further and yeah the brand isn't strong but i don't think it's an end-all be-all for this business kind of like how some stores back in the day if they can be the online store that actually works they can build that brand over

time because someone like nordstrom or macy's or jc penny back in the day when they were very successful businesses they had to invest a lot of capital up front to build that brand and then it becomes a cash flow machine with a moat over time yeah remember guys we are not financial advisors Anything we say on this show is not formal advice or recommendation. Thank you all for listening. We'll see you on our next episode. My sir. Come on, come on!

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