Description

FIGS is a health care apparel company, best known for selling scrubs to health professionals. Founded in 2013, they created a category defining brand in a previously commoditized sector. After a June 2021 IPO and much investor excitement, shares have declined ~80% as revenue has decelerated and concerns about competition and market potential have emerged. Still, FIGS remains the most recognizable brand in a healthcare apparel industry comprising 22m US professionals and estimated $12B potential revenue. FIGS also remains profitable, with >$250m net cash on a <$1B market cap that should provide ample time to reinvigorate sales.

Business model

FIGS sells primarily DTC online, which provides rapid customer feedback to inform marketing and product development decisions. It also avoids lower margin wholesale retail, and has developed enough brand recognition to be less reliant on paid advertising than peers.

One advantage of FIGS’ category is lower inventory risk, as scrubs are largely replenishment purchases. FIGS has limited history to fully prove this theory, but seems logical.

Value proposition

1. They make scrubs that are functional that health professionals feel more comfortable wearing during and after work.

2. FIONx proprietary fabric. The company touts its unique fabric as a source of comfort and technical advantage, and conversations with customers verify that Figs’ fabric is superior.

None of these are a true competitive advantage, but the strengths are acknowledged in conversations with customers.

Competition

Based on anecdotes and general observation, FIGS are the premium and best known scrub brand. Other peers include Careismatic Brands (fka Strategic Partners, includes Dickies, Cherokee, Medelita, others), Mandala, Jaanuu, Barco, Fabletics. Mandala is most often cited as the main competitor brand, with a similar aesthetic to FIGS at a cheaper price. A rough comparison of scrub top pricing and popularity is below:

Risks

Obsolescence. Apparel brands come and go, and although FIGS has been a standout success in a vertical where no one else has, they are not immune to competition. Lululemon, often cited as a comp for FIGS bulls, has been the exception rather than the rule in successfully building an activewear business. FIGS must continue innovating fit, fabric, and continue winning word of mouth to grow for years ahead.

Brick and mortar failure. The company has one retail store (“Community hub”) in Los Angeles, with another opening in Philadelphia this year. The LA store does not appear very successful thus far, as there are no plans to expand retail until meeting internal “proof points.” While this approach is prudent, it is a modest concern for a growth company for new initiatives to be met with tepid response.

Management turnover. FIGS currently has an interim CFO and a COO who joined in Feb23. This risk was mentioned in a Spruce Point short report (https://www.sprucepointcap.com/research/figs-inc), which valued the shares at the current price of ~$6.00. 

Lululemon or other established adjacent player chooses to compete. While the potential market size is attractive, marketing to health professionals is a different skill than targeting athletes, athleisure consumers or yoga practitioners. Lulu, Nike or any other number of established players could stand up a business, but it would be a complex undertaking.

Valuation

Building a rough DCF, current valuation assuming mid-single digit revenue growth implies long-term EBIT margins ~12%. These margins are modestly above recovery year 2024 targets (9.5-10.5% EBITDA).

At current price, FIGS seems like a limited downside opportunity (growth roughly in line with health care market, stable margins) with potential for meaningful upside if growth recovers, which would drive margins and possibly multiple expansion. If normalized margins settle somewhere above non-LULU peers (plausible due to DTC focus), the shares are likely cheap at current levels. 15% margins and 10%+ growth through 2029 implies >$9/sh. Any upside scenarios are tough to substantiate, but downside appears reasonably reflected in current price. While I would not pay for this possibility, moonshot scenario is if the brand emerges beyond healthcare, which management seems to think is realistic.

Incentives

Annual bonus moved to a formula in FY22, it had previously been subjective. Metrics are revenue (37.5%), EBITDA margin (37.5%) and Individual Performance (25%). [Note: Prior year was Rev (60%), EBITDA margin (25%), Strategic objectives (15%). There was no payment FY22 as targets were missed].

Long-term equity awards are RSUs and options vesting over 4 years. Amounts are subjective.

At 12/31/23, Trina Spear and Heather Hasson owned 12.5% and 9.3% of outstanding shares, which comprised 57.6% of voting power, slight increases over FY22. This is a guess, but if they got a compelling offer, I have not noticed anything that suggests they are so zealous to run the company forever that they would not consider it–Hasson has already stepped away from running the business. For all the criticism of management, they are highly incentivized to see FIGS succeed and overall pay is not egregious. 

Catalyst

• Return to growth. The story is reasonably straightforward. If results convince investors Figs is not a flash in the pan brand destined for irrelevance, it will likely trade at a much more attractive valuation.