Description

Investment Summary

I recommend Stich Fix (“SFIX”). SFIX has a $2.1B market capitalization, no debt, and will generate ~$1.2B in sales in FY 2018. The stock is trading at 1.6x FY 2018 Sales.  This is an attractive valuation for an internet-based consumer company that is growing sales at >20% per year, building a large database of proprietary intellectual property, and benefitting from a secular shift of clothing sales moving online. At 20% compound sales growth, In FY 2021, SFIX will generate $2B in sales. The valuation multiple should expand as SFIX grows because the competitive advantages in data collection, personalization, customer acquisition, and product assortment, will intensify with scale. At 2.5x FY 2021 sales, SFIX would be valued at $5B, a 2.5x return.  

            I believe it is reasonable to use a multiple of sales, rather than earnings, because SFIX is investing in talent (i.e. data scientists) and marketing in order to position the business to address a large and growing market, which weighs on profitability and makes the business look expensive as a multiple of earnings. This was true of other high-growth ecommerce companies, which look expensive on traditional earnings metrics because the businesses require operating expense investment to scale in order in order to establish a strong competitive position in large new markets driven by global internet adoption.

            I believe the same phenomenon will apply to SFIX for some time. In 2016, the U.S. apparel/footwear/accessories market was a $353B market; $55B of the market was online (15.5% penetration). By 2021, SFIX estimates that the market will grow to $421B, with $94B online (22.3% penetration). SFIX is investing to position the business for the growing online apparel and accessories market opportunity.

             Stitch Fix was founded by Katrina Lake. Ms. Lake remains CEO, and is one of the youngest CEOs of any public company. Ms. Lake owns about $300mm in stock, and has grown SFIX from $77mm in sales in 2014, to over $1B in sales in 2017. After the SFIX IPO in Nov. 2017, Ms. Lake is now one of the wealthiest self-made women in the country. She has created an entirely new online apparel business model, and built a workforce of nearly 6,000 employees, the majority of whom are women. She has publicly-stated that she wants to build the retailer of the future and is committed to building shareholder value over the long-term.

Business Description

SFIX is an online apparel business that uses a combination of proprietary data, and personal stylists, to sell clothing. Customers sign-up for SFIX online, and fill out a personal profile on clothing style preferences, sizes, and price points. The customer is then assigned to one of SFIX’s over 3,000 personal stylists. Using a combination of proprietary data and personal judgment, the stylist chooses five items from SFIX’s inventory for the customer. The five items are mailed to the customer; the customer keeps what they like, and sends back what they don’t. The customer pays a $20 styling fee upfront, and pays for each item that she decides to keep. Shipping is free for the customer both ways.

            Today, SFIX’s ideal customer is a person who does not have time to shop, hates to shop, does not have easy access to physical apparel retailers, has undergone a recent change in body type and needs assistance, or who values the help of a professional stylist because the person lacks fashion sense. The ideal customer is not a trendy, fashion-forward, style-conscious customer who knows the brands and styles that fit their body, has access to a lot of great stores, has time to shop, or enjoys shopping. This is an important distinction in understanding the value that the SFIX service can deliver to customers. The combination of convenience and personal styling is the primary value proposition today.

            SFIX’s capacity to collect and synthesize large amounts of personal data on consumer apparel preferences is a sustainable competitive advantage. When customers fill out the personal style profile, the customer is sharing intimate and personal data about their body and taste. SFIX uses this data to personalize the box of five items for each customer. As the data set grows, the algorithms that drive the personal recommendations will improve, thereby creating more value for customers because the customer will receive apparel that is more suited to their tastes. From 2014-2017, the average number of items purchased by customers per shipment has increased 22%, suggesting that recommendations are becoming better as the business scales. The ability to personalize at scale is a competitive advantage of internet-based consumer companies.

Why Wall Street may misunderstand the stock

1-Wall Street is disconnected from the core customer-As stated above, today, the primary SFIX customer is a person who does not have time to shop, hates to shop, does not have easy access to physical retailers with a broad assortment of good brands, has undergone a recent change in body type and needs help finding new clothing, or who values the help of a professional stylist because the person lacks fashion sense. Collectively, this is a massive market that is vastly underestimated by peope that have easy access to a lot of great stores, or who love and care about fashion.

2-Amazon Threat Amazon will soon dominate the online apparel and accessories market in the United States that is driven by price, selection and convenience----but the one area of the market where Amazon is unlikely to dominate is personal styling. The online personal styling market is going to be won by the Company that establishes and nurtures an intimate emotional connection to its customers. This is not Amazon's core competency. SFIX is building its entire business and brand around cultivating these personal relationships at scale. Personal styling should serve as as durable substitute for people that hate to shop, don't have time to shop, or value help with shopping, particularly as more shopping moves online.

3-Underestimate the value of the Data:

SFIX has established a business model that collects high signal, sensitive data. Women (and now men) are providing data about their body type, insecurities, weight, and other deeply personal information. The customers are doing this because they want SFIX to help them find clothing that is stylish, fits them well, and makes them feel better.  This data provides the foundation for a lifetime customer relationship built on the trust and intimacy that is required in order to feel comfortable allowing another person to know about your body, and choose your clothing. Over time, the technology will make this relationship deeper, more personal, and more meaningful through augmented reality, body scanning, and other innovations that collapse the physical barriers between two people communicating online.

4-On-Demand Online Apparel and Accessories Store-Not a Subscription-Box Business

Many on Wall Street are analyzing this business as a subscription-box business, and therefore are using metrics like churn and CLV. There is a stigma around subscription-box businesses due to Blue Apron's collapse in the public markets, and the reported challenges faced by services such as Rent-the-Runway and Birchbox. I don't think SFIX should be viewed as a subscription-box business. The business more resembles an online apparel and accessories department store that has built a better business model by using the internet to personalize product recommendations at scale. It seems that the appropriate metrics to assess the business are inventory turns, gross margin, return on incremental capital, and full-priced sell through of inventory. SFIX is an on-demand, 24-hour, personalized apparel and accessories retailer that makes money by selling through inventory at full-price --not a subscription-box business that makes money selling subscriptions--I believe that disconnect is an overhang on the stock.

Paths to Increase Business Value in the Public Market

Any, or all, of these strategies/catalysts/events could make the company worth multiples of the current price:

1-SFIX is Acquired-High-quality consumer internet companies with proprietary data, a strong brand, direct consumer relationships, and +$1B in sales are scarce assets that are often bought by larger companies that are structurally incapable of developing these assets internally. SFIX is a logical acquisition target for Walmart, Zara, H&M, LVMH, Amazon, Target, TJ Maxx, and several other large companies that are seeing their apparel businesses move online. Amazon would be most powerful because the combination of SFIX's brand, personal data, and +3000 stylists, combined with Amazon's buying power, Prime subscriber base, logistics, growing private label assortment, and global scale, would be a strong combination. Apparel and accessories are a gigantic and important category for retailers because they are staples that can drive traffic across broad ages and demographics with seasonal turnover that creates a new reason to come to the store.

2-SFIX Consolidates smaller direct-to-consumer online apparel businesses-With a clean balance sheet, good cash flow, and a public equity as a currency, SFIX is well-positioned to acquire smaller online apparel businesses, eliminate duplicative costs, and leverage its scale and the combined data set to build more value in the consolidated entity. There are several sub-scale, unprofitable online direct to consumer apparel businesses with strong brands and loyal customer bases. As a pure-play public company with $1B in sales, SFIX could offer the founders and VCs in these smaller-private businesses an efficient way to monetize their investment, while retaining the upside that could come from the growth of a larger consolidated company. SFIX is at the perfect size in both sales, and market capitalization, where a disciplined consolidation strategy can build tremendous value as a public company. 

The plus-size women's apparel market in the United States is a particularly attractive area for SFIX to consolidate. Physical retailers are structurally ill-suited to serve the plus-size market becuase the in-store experience is not pleasant for the customer, the product assortments are deficieint, and most branded apparel companies are not truly committed to the category. This market should be better served online. The women's plus-size market in the United States is a 100 million-women population. The market is huge and underserved---In 2016, it was estimated that 67% of U.S. women qualify as plus-size, but only 18% of clothing sold was plus-size. This is a market that is primed for innovation in product, experience and service. There are some seemingly strong online specialty plus-size companies in the U.S., such as Gwynnie B and Dia, that SFIX could potentially consolidate in order to build a dominant position in the online plus-size women's market, which would be a highly defensible market position, would lead to a structurally higher valuation multiple, and would make the business desirable, maybe essential, to large strategic acquirors. When Stitch Fix launched its plus-size offering in Feb. 2017, there was a waiting list of 75,000. 

3-International Expansion-SFIX has no international revenue today. The business model should scale internationally because it can leverage its data and capitalize on the consumer awareness of its brand as the market leader in online personal styling. Many of the same fundamental demand drivers for the service in the United States should also exist abroad. As with many consumer internet companies, the international market could represent a larger market opportunity than the United States. 

4-Proprietary Clothing brands-SFIX is going to be well-positioned to develop its own private label clothing brands because the data should reveal gaps in the market for new styles, fits, fabrics and colors. The existing direct relationship with customers will lower customer acquisition costs and provide an efficient distribution channel for launching new proprietary products. Private label clothing is higher margin, and can differentiate the business.

Catalyst

1-continued execution

2-acquired