Why Is Everyone Talking About Stitch Fix Stock?

Stitch Fix (SFIX -1.32%) recently made the headlines for all the wrong reasons. The online apparel retailer posted a disastrous fiscal third-quarter earnings report after the market close on June 9, and its stock sank 19% to an all-time low the following day.

A barrage of analyst downgrades exacerbated that pain, and its stock now trades nearly 60% below its initial public offering (IPO) price and more than 90% below its all-time high from last January. Let's review the business, why the stock was crushed, and if there's any hope left for Stitch Fix bulls in this unforgiving market.

What does Stitch Fix do?

Stitch Fix isn't a traditional apparel retailer. Instead of letting customers choose their own clothes, the company's platform gathers data on its shoppers with an online survey and artificial-intelligence algorithms. It then charges a "styling fee" of $20 before curating bundles of five items for customers.

Its customers pay for the items they want to keep and return the rest with a pre-paid shipping envelope. If they keep at least one item, the initial styling fee is deducted from the final price. If they keep all five, they receive a 20% discount. The company doesn't charge any subscription fees, and its deliveries can either be requested on demand or set on a regular schedule.

Is Stitch Fix's business model sustainable?

Stitch Fix continued to gain active clients from fiscal 2018 through fiscal 2021 (which ended last August). It struggled with slower sales in fiscal 2020 as the pandemic throttled consumers' demand for new apparel and disrupted its warehouse operations, but its business bounced back in fiscal 2021.

However, Stitch Fix subsequently lost active clients in the first nine months of fiscal 2022, and its revenue growth has slowed to a crawl.

Data source: Stitch Fix. YOY = year over year.

The company partly attributed that slowdown to its launch of its Freestyle service last September, which allows shoppers to purchase curated products without ordering a full "fix" of five items. That approach might help Stitch Fix better control its logistics expenses as fuel costs surge, but it could also cannibalize the core business model.

It also said Apple's privacy update for iOS, which allowed users to opt out of data-tracking features, generated additional headwinds.

For the fiscal fourth quarter, management expects revenue to decrease 13% to 15% year over year. That would translate to a 1% drop for the full year and represent its first annual revenue decline as a publicly-traded company.

Focusing on profits instead of growth

As Stitch Fix expanded, it struggled to stay profitable while its logistics costs rose, and it increasingly relied on promotions to gain new shoppers. 

The company was profitable on a GAAP (generally accepted accounting principles) basis a few years ago, and it reported a better track record of positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). However, its GAAP losses have deepened recently.

Data source: Stitch Fix. 

For the fiscal 2022 fourth quarter, management expects to post negative adjusted EBITDA of $25 million to $30 million, which will cause that metric to turn negative for the full year.

Stitch Fix plans to lay off approximately 15% of its salaried positions (or 4% of its total headcount) to rein in costs, but that move will also cause it to incur $15 million to $20 million in one-time charges in the current quarter before it generates $40 million to $60 million in projected savings in fiscal 2023.

Can Stitch Fix survive this difficult transition?

Stitch Fix ended its third quarter with no debt and $235 million in cash and investments, so it can slog through an extended period of slowing growth and widening losses.

Unfortunately, supply chain constraints, inflation, and softer consumer spending will also likely throttle its growth for the foreseeable future. As a result, analysts expect revenue to rise just 3% in fiscal 2023, while net income and adjusted EBITDA stay deep in the red.

It deserves its discount valuation

Stitch Fix trades at just 0.3 times next year's sales, and its market cap of less than $700 million might make it a compelling takeover target for a larger apparel retailer.

That low valuation could also limit its downside potential going forward, but it also won't attract any bulls until the company stabilizes its client growth and narrows its losses. So for now, investors should simply avoid Stitch Fix and stick with more recession-resistant stocks to ride out this volatile market.