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Why Investors Are Curious About Stitch Fix’s Evolving Model

Stitch Fix‘s (NASDAQ: SFIX) business doesn’t seem to be firing on all cylinders. In this video clip from “The Virtual Opportunities Show” on Motley Fool Live, recorded on May 31, Fool.com contributors Rachel Warren, Travis Hoium, and Demitri Kalogeropoulos discuss how a new part of the online styling service is growing, but its core offerings are underperforming, which has been confusing for investors.

Rachel Warren: I am watching this company. I’m really curious to see what that performance is going to look like when they report their third-quarter results here in a little over a week. This is not one I would buy at this moment in time. It’s one I want to look into a little bit more. I will say their Freestyle revenue, which again, that’s the more recently launched side of their business where you don’t have to go through a stylist to buy something through Stitch Fix.

Revenue from that segment grew 29% year over year in the second quarter. That could be another real potential catalyst for growth there. I think it’s a company to watch. I have probably more higher conviction stocks in this space that they have my eye on. But as I’m digging more into the business, it’s one I definitely want to learn more about.

Travis Hoium: I was just looking at their S1. One of the things that I think is interesting in this space is they have very clearly, I know somebody who is used to be a stylist for them and they really liked it when they first started. It was a very flexible schedule. People would actually request that somebody that they worked with in the past would style them.

If you go back to their business outlook, I looked at their S1, so they made a net income of $21 million in 2015, $33 million in 2016. Then they start preparing themselves to go public and go public what changes as a public company is expectations for growth go up.

Warren: Yeah.

Hoium: It seems like one of those businesses where they should just be who they are, which is just a really cool niche. I don’t particularly like fashion. It’d be great if I could just have somebody [laughs] else pick my clothes for me, my wife does that primarily, so but this is one of those ones I struggle with is, they’re clearly moving to like the AI model. Because they are replacing their personal stylists and they had a whole bunch of layoffs last year, I think it was.

But I don’t necessarily know that that’s the right move because fashion is such a weird thing that it’s like if somebody does a really nice job fitting my style does the computer going to do the same thing? Anecdotally, I have heard that that has not gone over well with customers. Based on the numbers, you would think that that holds with the financials as well.

It’s this weird spot and then the founder left, I think it was last year so it’s a strange stock. It’s like one of those ideas where it should just be a normal, profitable, but not super high growth business and just go, here’s what we do, we do it really well if you want to use us, cool.

Warren: Yeah. Well, and it’s interesting because even though that revenue from that newer side of their business was up about 30% year over year management said, “We’re observing challenges with onboarding and conversion of clients and are beginning to direct new clients to a clear and easy fix onboarding path,” which would be that more traditional going through a stylist route. Which as you mentioned, that’s been the bread and butter of their business.

Hoium: That’s what they do. [laughs]

Warren: [inaudible]. It doesn’t make a lot of, I think it’s confusing maybe as a consumer, but also as an investor. It’s like are you trying to gear away from that or are you just trying to diversify your business model? What’s the end goal here? I think that’s what investors aren’t quite sure about.

Demitri Kalogeropoulos: The management didn’t give a really bullish guidance for the Q3. They’re projecting sales of between $485-$500 million for this quarter, which would be between 10% to 7% decline year over year, and then their margins, they’re suggesting losses even on an adjusted earnings basis too.

I’ve been following them for a while too, I’m in the same camp as you guys too. I’ve wanted to like this stock for a long time, but there are enough red flags that I can understand, particularly the founder leaves churn up there at the top. Then this sort of core business strategy tension there in terms of are we selling things directly to people or are we using AI, are we using what is our really big core offerings?

I think once they land on that, they can have a really good future ahead. But right now there’s too many big questions I think around that one.

Demitri Kalogeropoulos has no position in any of the stocks mentioned. Rachel Warren has no position in any of the stocks mentioned. Travis Hoium has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Stitch Fix. The Motley Fool has a disclosure policy.

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