Author Topic: SFIX - Stitch Fix  (Read 7083 times)

ajc

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SFIX - Stitch Fix
« on: December 29, 2018, 04:03:20 PM »

Overview

Stitch Fix is an online styling service that delivers a box of personalized clothing (on a subscription basis, or a la carte). You fill out a profile on sign-up and are assigned a stylist. Based off of Stitch Fix's selection algorithms, your stylist handpicks pieces around your tastes, fit, and budget. They're mailed to you, and you keep what you like and send back what you don't. You give feedback for each item, kept or returned, on how you liked/disliked the fit, style, etc. Over time, Stitch Fix's AI and your stylist learn your preferences on every metric and deliver an ever more personalized selection.

The business is on track to grow FCF by over 100% YoY in 2019 and is selling for 14 times estimated 2019 free cash flow. The shares are down 70% from recent highs, because analysts have a superficial understanding of the company and compare it to Blue Apron. Stitch Fix shares also dropped a lot recently based on slightly below expectation user growth and the general NASDAQ decline.

The right way to think about Stitch Fix is as a new, deeply personalized, quality-first model for apparel retail. It's more like a combination of Google Search and Starbucks for clothing instead of some undifferentiated subscription box company. Spotify, Pinterest, and others try find the exact song, coffee table, etc, that fits you. Stitch Fix is changing apparel retail by doing the same for what you wear.

Their latest investor presentation - https://investors.stitchfix.com/static-files/be146355-1123-41f8-8128-b690d51d7b73


User and financial prospects, plus expansion opportunities

Stitch Fix is growing users and revenue by 20%+ annually and increasing ARPU at a good clip too. TTM revenue was $1.3B versus their current $1.7B market cap. Some of their stated long-term targets are: gross profit margin of 45%, operating profit as a percentage of revenue of 11%, adjusted EBITDA as a percentage of revenue of 12% (see investor presentation above). Stitch Fix recently expanded into the UK (their second country after the US), so this increased addressable client market should start to show up in 2019.

Once Stitch Fix has completed their UK launch execution, the company should be able to take a playbook approach towards similar territories. Places like Canada, Australia, Hong Kong, and Singapore, seem like sensible choices. Western Europe or Japan probably require more nuance, but are also options.

Stitch Fix, founded in 2011, has only now started to go beyond their female offering. Men was launched in late 2016, Plus Size in early 2017, and Kids in mid-2018. Those areas still have untapped growth potential (Kids especially since they grow out of clothes fast). Further, because Stitch Fix is the most personalized mainstream offering there's a chance for them to one day expand into big ticket, high margin items like wedding dresses, jewelry, etc.


If Stitch Fix isn't another Blue Apron, what is it?

Two comparisons....

First, Google Search understands your preferences and can predict them while you're typing. Until now, clothing has been mass manufactured to standard fits and patterns by manufacturers, then put on store racks. It's not personalized and the store has no memory of you. Stitch Fix builds up a profile of your exact preferences, so like Google Search the more you use it the better it gets.

While Amazon often suggests bizarre additions to your basket based on their algorithm, Stitch Fix actually knows what it's doing. Amazon Prime Wardrobe is seen as Stitch Fix's biggest competition, but Amazon has a long way to go even with their regular recommendation AI. Like Google Search, Stitch Fix has a virtuous circle at work. More clients means more feedback, more feedback data allows it to get more accurate at predicting preferences. A reputation for accurate prediction drives brand awareness and attracts new clients, and so on and so forth.

Starbucks is another worthy comparison. They originally persuaded consumers to pay a premium for overall experience, a good quality cup of coffee, and some snob appeal. Their brand positioning allowed them to not have to compete too heavily on price. Starbucks is standard today, but there was a time at the beginning when most considered it crazy to shell out $5 for their coffee. Howard Schultz figured that society's spending power would catch up and the Starbucks experience would eventually be appreciated and democratized. Lake has been smart about positioning the Stitch Fix brand in roughly the same way, so Stitch Fix has a long-term opportunity to maintain a premium valuation over its peers.

Stitch Fix is also uniquely innovative in that every client now has their own personal tailor. Users will often tell their stylists about the child they're expecting, wedding dates, etc, so the stylist knows exactly what to provide and the relationship can become deeper and more long-term as a result. This is reciprocal in that stylists send notes to clients with each fix too. There was a time when only the rich could afford their own private tailor, but Stitch Fix is scaling that. It's a luxurious idea, but like Netflix, Spotify, etc, consumers in future will expect fully personalized clothing offerings on size, fit, style, etc, and Stitch Fix is currently best-in-class at this.


Financial performance, economics of the business, and competitive advantages

Stitch Fix has been profitable almost since the start. It has no debt. It's unclear how long they'll keep up their current strong FCF growth, but it's inexpensive based on where FCF will be for 2019 together with their revenue and user growth opportunities.

They don't have the real estate expense often associated with retail. That also means no costly need to update and remodel your stores regularly. Stitch Fix does have to keep setting the standard with their core business proposition, but their model and brand positioning means they get to avoid much of the crappy economics retail is known for.

As mentioned previously, their overall dataset and ability to analyze it gives them the opportunity to become almost a Google Search (with mapping capability) for clothing. As long as they continue to lead there, they can build a competitive advantage around that. It'll enable them to attract more clients and they'll also be able to attract the best clothing brands since those brands will want to be in front of the most discerning consumers.

Stitch Fix manages inventory better than others since their data gives them a far clearer idea of what people will buy. That means there's less waste and capital tied up in inventory. While Amazon is a low-cost, quick shipper, Stitch Fix is not a discounter and has a brand known for personalization and client service. This also allows Stitch Fix to offer itself to brands as a platform that maintains some sense of exclusivity and pricing power.

Stitch Fix could therefore continue positioning itself as a higher-end, truly personalized platform and reap the benefits. For many consumers and brands, having a classier, higher quality alternative to Amazon would be both competitively useful and financially valuable. Stitch Fix would end up with the various economic and competitive advantages that platform status would bring.


Management, culture, and data science

Katrina Lake is a highly intelligent, driven, and grounded CEO with 10%+ ownership. You can get an idea of her business instincts and mind at work by listening to these discussions - https://www.youtube.com/watch?v=Lk2_Q507g8I & https://soundcloud.com/adam-berke/target-audience-podcast-episode-4-katrina-lake. She recruited Eric Colson from Netflix in 2012 to head up algorithms and data science, as well as folks like Mike Smith, Cathy Polinsky and Paul Yee to the management team. VC's like Steve Anderson and Bill Gurley were also both persuaded to invest even though she was an unproven quantity at the time with no experience running a retail business.

Culturally, Stitch Fix is known for having an open, friendly work environment with an emphasis on hiring people who know their business inside out and can execute plus advance the company into new areas. They employ mostly women and are obviously female led. This might give Stitch Fix a slight advantage in recruiting top female talent, since Silicon Valley can sometimes be a slightly challenging place for women to find safe, equal working conditions.

Data is vital across the organization and it's used not just for clothing algorithms, but also for warehouse and inventory efficiency, as well as product testing among other things. Stitch Fix also employs more data science PhD's than any other pure apparel retailer and is a favored destination for female STEM graduates. For those interested in going into the weeds, I highly recommend the Stitch Fix Engineering and Data Science blog (https://multithreaded.stitchfix.com/blog/) to see how data is used and what it's used on across the company. Basically, every aspect of the business is analyzed in order to create greater efficiency and better customer outcomes. This focus will likely pay off nicely over the long-term.


Risks and negatives

As an investor with an owner-oriented mindset, I wish their emphasis on FCF was more front and center in their financial reporting and letters. That said, I'm glad they cover it and am happy overall with what they focus on.

Amazon Prime Wardrobe is their main competitor even though it focuses on delivery speed and price instead of personalization. This, together with Amazon's AI difficulties, will probably ensure that Amazon stays behind Stitch Fix in this market even if they'll have more volume. Stitch Fix clearly can't rest though since Amazon is know for plugging away at weaknesses for years until they're solved.

Katrina Lake owns 10%+ of the shares which is highly encouraging, but as with many Silicon Valley companies she also has super voting shares. While this is almost standard these days for many new companies in tech or related industries, I'd prefer not to see it. It does prevent Stitch Fix being bought out (and screwed up) though, for a cheap price relative to the long-term value they'll likely create.

Glassdoor ratings for Stitch Fix have recently trended lower from 3.8/5 to 3.3/5. While retail is a tough industry so this is understandable, I think they need to put effort into addressing the root of this.

Stitch Fix has also chosen to operate in an industry where yesterday is past and clients only care about how good you are today. As soon as they stop continuously improving their core offerings, or pay less attention, or any number of things, they'll create space for others. While that doesn't mean Stitch Fix should throw away their intelligent approach of growing and expanding thoughtfully, it does mean complacency is clearly a non-starter.

Finally, founder/CEO Katrina Lake is integral to the company going forward and so there's key woman risk. If she were hit by a bus tomorrow or her performance dropped off noticeably over time, that would materially impact the ability of Stitch Fix to continue to lead their market. The same likely goes for Eric Colson and potentially Mike Smith from the management team. Cathy Polinksy, Paul Yee, and 1 or 2 others, would also take time to replace.


Recommended reads

https://hbr.org/2018/05/stitch-fixs-ceo-on-selling-personal-style-to-the-mass-market

https://www.forbes.com/sites/ryanmac/2016/06/01/fashionista-moneyball-stitch-fix-katrina-lake/

https://www.reforge.com/blog/stitchfix-personalization-retention-monetization

https://www.goodwatercap.com/thesis/understanding-stitch-fix

https://techcrunch.com/2017/10/22/unboxing-stitchfixs-s-1/




clutch

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Re: SFIX - Stitch Fix
« Reply #1 on: December 29, 2018, 04:46:27 PM »
"This, together with Amazon's AI difficulties, will probably ensure that Amazon stays behind Stitch Fix in this market even if they'll have more volume."

What's your basis for saying that Amazon has AI difficulties? Amazon probably hires 10x more PhDs in machine learning than this company... considering they also have more volume (data) it seems like they'd have much bigger advantage in AI.

KJP

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Re: SFIX - Stitch Fix
« Reply #2 on: December 29, 2018, 05:57:54 PM »
Have you tried the service?  I did and found the curation poor (sending me clothing types I said I did not want), overpriced and, in several instances, not unique, e.g., a sweater from Banana Republic.  I've asked a few others who tried the service and they had the same impression.  I tried them a couple of years ago, so perhaps they've improved.

Also, there are other competitors, such as Trunk Club, but I'm not sure how well any of them are doing. 

johnny

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Re: SFIX - Stitch Fix
« Reply #3 on: December 29, 2018, 10:55:27 PM »
I'm not sure I buy the data/moat argument here. I question how sophisticated such an operation can be, given how costly data point collection (Netflix can pull about 100 signals from you cruising around the carousel, at zero cost). The attached graphic in the presentation doesn't exactly impress me.

Data-y moats start to build when you begin to know things about the user that they don't know or aren't factoring in correctly. "Dana is 172.7 centimeters tall" is a fine enough thing to know, but it's not exactly the Colonel's Recipe, and I'm not sure how much proprietary signal they can credibly claim to have on Dana that prevents FitchStix from coming around and peeling off a chunk of their users with some novel gimmick.


ajc

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Re: SFIX - Stitch Fix
« Reply #4 on: December 30, 2018, 01:23:32 PM »

"This, together with Amazon's AI difficulties, will probably ensure that Amazon stays behind Stitch Fix in this market even if they'll have more volume."

What's your basis for saying that Amazon has AI difficulties? Amazon probably hires 10x more PhDs in machine learning than this company... considering they also have more volume (data) it seems like they'd have much bigger advantage in AI.


So, in 2015 Stitch Fix actually had a bigger data science team than Apple, LinkedIn, Twitter, Google or Amazon (https://www.mercurynews.com/2016/12/15/computing-out-fit-stitch-fix-algorithms-machine-learning-dress-customers/) and that team has grown by over 30% since then. Furthermore, data science and AI is part of the Stitch Fix core and is what the company was built around.

Amazon, while strong in that area, was really built as a shopping website backed by an innovative warehouse and logistics operation (that was my sense when I worked there). Obviously, they later opened their physical and computing infrastructure to others.

While I'd argue Amazon is pretty decent on the AI front, to my mind their forte was much more in building practical industrial size hardware and software systems that could scale quickly and robustly. My 2 cents is when it comes to nuance, Amazon is not really the same as a Google or a Stitch Fix. It's like comparing Noma to McDonalds. Both do what the other can't, but if you figured out a way of scaling Noma it'd sound odd to say McDonalds has the better food production techniques. It depends on what you're after and for Stitch Fix there are enough people who want a more deeply personalized, stylist-based experience.

I'm not sure if you're aware, but Amazon Prime Wardrobe is not like Stitch Fix even though analysts peg it as their greatest threat (incorrectly to my way of thinking). With Prime Wardrobe you click on a bunch of items you like, choose your own sizes, styles, etc, and they get shipped to you. There's no personalization and Amazon has no deep preference data for you. Essentially, it's more of a quick and easy shipping service on top of the current retail store format where there are racks full of stuff you sort through yourself. Amazon is not really in the business of intricate personalization, and as good as they are generally it might be tough to teach an adult dog such new and different tricks.

A few obvious examples of where Amazon falls darn short on AI ability for the consumer side, can be found here - https://worldwideinterweb.com/funniest-amazon-recommendations-gallery/. I don't doubt all of us have experienced that. Also, if you buy a toaster they'll recommend you a hundred different other types of toaster over the following month. That's another one most people can relate too. Then there's the clear problem they're currently having with fake reviews which their AI is not good enough to pick up and delete. Not to be too hard on Amazon here, but some of this stuff is just about getting the basics right.

Anyway I don't think Amazon is terrible or Stitch Fix is perfect, but I'd say for anyone who looks at who has the better consumer facing recommendation AI, it's clear Amazon still has some completely obvious stuff they need to take care of before they can be taken really seriously on that front.

This is a great presentation about where Stitch Fix's currently is on this - https://www.youtube.com/watch?v=z_OGYzT_MBo



ajc

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Re: SFIX - Stitch Fix
« Reply #5 on: December 30, 2018, 01:33:56 PM »

Have you tried the service?  I did and found the curation poor (sending me clothing types I said I did not want), overpriced and, in several instances, not unique, e.g., a sweater from Banana Republic.  I've asked a few others who tried the service and they had the same impression.  I tried them a couple of years ago, so perhaps they've improved.

Also, there are other competitors, such as Trunk Club, but I'm not sure how well any of them are doing.


Ha. I can't since I'm not from the US, but I know you're not the only one who that's happened to. Since 2013, my Stitch Fix research on the customer satisfaction and comparison side has been through blogs, YouTube videos, fashion sections of national newspapers, clothing magazines, etc. I've gone through a couple hundred of them to get a sense of the average consumer's attitude towards Stitch Fix with a focus on those articles where they'll compare a bunch of services that do the same thing. I also get a daily Stitch Fix alert from Google with the top five or ten news stories, blogposts, etc, about the company.

Over time I've been able to build up a pretty solid sense that Stitch Fix is the best bet in the space. Clearly the rebuttal could be I've not used it so that's a point against, but I tend to think I get to look at the numerous reviews and data instead of relying on my individual positive/negative experience. I guess there are pros and cons to both.

Like you say, there's Stitch Fix, Trunk Club (acquired by Nordstrom), Dia & Co (for plus size), Wantable, and others in the space. I've noticed Stitch Fix is usually the most favored by a clear margin and because of/related to that it's also been the best at scaling (see images attached below). Also, because Stitch Fix does women, men, and kids, I think it offers working mothers the chance to do all their shopping in one place. That's a practical advantage competitors might overlook.

To be more specific about onboarding and curation, I'd say your experience is a problem for the business model. That goes for the whole space though, not just Stitch Fix. There's an element of randomness and that is strongest in the beginning. In a perfect world, everyone would stay with the service for 6 months for their preferences to become far more obvious. Clearly there's not a chance in hell that's going to happen.

The approach as far as I can tell is for Stitch Fix to simply be better on average than the competition in the start and through the customer's lifetime. There will be unhappy clients who leave after mediocre experiences, but at this stage of the technology and business model I think it's more of a numbers game where you try beat the odds and maintain a strong net promoter score. From an investment point of view, it sucks to hear that happened to you and from the same point of view it's also completely understandable given there's randomness in the model and that means bad initial experiences for a certain amount of people.

Interestingly, this is a common thing for a lot of tech that I can think of. These days and in the past. There was a time when Amazon had Xmas screw-ups with late deliveries though they were always much better than the competition on average. Nowadays, Uber and Lyft started out with some really terrible reviews and so riders would switch services. Same with UberEats, Doordash, GrubHub, and Postmates for food delivery. Some of the reviews really lay into them and swear you should use X instead of Y. Scroll down a little and someone else is saying the exact opposite with just as much dissatisfaction.

I think it's somewhat in the nature of a lot of these businesses that there's a given amount of unhappiness in the start. For Stitch Fix, I'd say it's more likely because of the styling fee and the sense a client might end up empty-handed. There's two ways to look at that perhaps. One is it's better to stick to businesses where that stuff's been ironed out and the experience is good from the start almost always (say Uber these days, just for example). Another way to look at it is that Stitch Fix must be pretty good if they can succeed in a business where the first few months are actually that hard to make a customer conversion in. I tend towards the first, but I admire what Stitch Fix has achieved given the clear challenges.


ajc

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Re: SFIX - Stitch Fix
« Reply #6 on: December 30, 2018, 01:36:26 PM »

I'm not sure I buy the data/moat argument here. I question how sophisticated such an operation can be, given how costly data point collection (Netflix can pull about 100 signals from you cruising around the carousel, at zero cost). The attached graphic in the presentation doesn't exactly impress me.

Data-y moats start to build when you begin to know things about the user that they don't know or aren't factoring in correctly. "Dana is 172.7 centimeters tall" is a fine enough thing to know, but it's not exactly the Colonel's Recipe, and I'm not sure how much proprietary signal they can credibly claim to have on Dana that prevents FitchStix from coming around and peeling off a chunk of their users with some novel gimmick.


So, Eric Colson (Chief Algorithm Officer, Stitch Fix) worked at Netflix for 6 years and was their VP of Data Science and Engineering. According to him, Netflix doesn't come close to Stitch Fix in terms of data science & AI.

See 6min00secs for that quote, but anyone who wants to understand Stitch Fix should likely watch the whole thing - https://www.youtube.com/watch?v=z_OGYzT_MBo



KJP

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Re: SFIX - Stitch Fix
« Reply #7 on: December 30, 2018, 02:46:54 PM »

Like you say, there's Stitch Fix, Trunk Club (acquired by Nordstrom), Dia & Co (for plus size), Wantable, and others in the space. I've noticed Stitch Fix is usually the most favored by a clear margin and because of/related to that it's also been the best at scaling (see images attached below). Also, because Stitch Fix does women, men, and kids, I think it offers working mothers the chance to do all their shopping in one place. That's a practical advantage competitors might overlook.

I also have personal experience with Trunk Club ("TC") and thought it was worse than Stitch Fix ("SF").  TC had the same curation issues and was even more overpriced than SF, in part because they're shipping Nordstrom's private labels, which I believe are more expensive than SF's.

I agree with you that curation should improve over time, which should also help margins by lowering returns.  But I was concerned about pricing.  SF's current and long-term target gross margins are around 45%.  If I recall correctly, Nordstrom, Macy's, GAP and Urban Outfitters, on the other hand, have gross margins in the mid- to high-30's.  What drives the difference? 

Part of it could be accounting in that the brick-and-mortar retailers may include store operating costs in COGS (I haven't checked).  But my sense from the personal experience with SF was that they were charging full price, while other retailers have to discount.  I know SF has introduced some of their own labels, and it's easier to get away with higher GMs if  people cannot price compare.  But if you're selling third-party items that customers can find cheaper elsewhere online, how sustainable is that?  Or perhaps the question is how big a market is there for that kind of service?
« Last Edit: December 30, 2018, 02:48:33 PM by KJP »

bizaro86

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Re: SFIX - Stitch Fix
« Reply #8 on: December 30, 2018, 04:52:21 PM »
I could see them getting relatively significant discounts from fashion labels at a certain scale as a way to "push" product. It also seems likely they would be uniquely placed to buy fashion close outs and sell them at full price.

So the improved margins could be in the cost side of the ledger as well as the pricing side.

Thanks for the idea, I had heard of them previously but just assumed they were venture/private.

KJP

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Re: SFIX - Stitch Fix
« Reply #9 on: December 30, 2018, 05:38:59 PM »
I could see them getting relatively significant discounts from fashion labels at a certain scale as a way to "push" product. It also seems likely they would be uniquely placed to buy fashion close outs and sell them at full price.

So the improved margins could be in the cost side of the ledger as well as the pricing side.


If it's a scale benefit, then GM should increase as revenue increases.  That's not the case.  They've had steady GM (44%) over the last three years despite a near doubling of revenue.  See slide 16 here:  https://investors.stitchfix.com/static-files/be146355-1123-41f8-8128-b690d51d7b73 
Also, the long-term management target model projects 45-46% GM, so no big scale benefit on the GM line even at maturity.  [See slide 19]  Instead, future profit margins will be driven by (according to management) SG&A leverage.  Thus, management sees scale benefits showing up further down the income statement, rather than via GM.

Your other hypothesis -- that fashion labels use them as a way to get rid of excess inventory -- is possible.  But if that's true, it would only increase my concerns about being able to sell at full price, because there's a greater risk that the same product is available much cheaper through another channel.