SFIX keeps demonstrating why it is a Best Idea Short. Our call back in February with the stock at $79.62 was that the new Direct Buy initiative would turn this company from a niche subscription model to a typical retail model and have a dramatic negative impact on the company financials and ultimately the multiple of the stock. The call has played out faster than we would have thought with the implementation of Direct Buy (now known as Freestyle) having as much of a dilutive impact on the overall model as we expected while also displaying clear cannibalization on the core Fix business. On top of that, the initiative is underperforming expectations. After the massive selloff in the past few weeks, we moved SFIX a few notches lower on our Best Ideas Short list earlier this week expecting the company to put up a beat on this print given the bloated 70% inventory rate it ended last quarter. As we anticipated, revenue and EPS beat on unanticipated strong gross margins with EBITDA more than 2x the consensus. Despite the slowing revenue trends, that would be good enough for a squeeze… until you see the guidance. Customer growth has stagnated and SFIX is expecting a material sequential drop in customers for 2Q. 2Q revenue is being guided down 12% and the full year is being revised to HSD growth while the street was expecting mid to high teens. The revenue shortfall is being credited to lapping the referral program of 1H 2021, lower marketing as the company tackles IDFA, and lower fix conversion rates with the company testing onboarding experiences. That last point is an interesting one. Go back 10 months when we went short, and the bull case was around accelerated revenue growth from greater wallet share on the growing customer base due to the Direct Buy/Freestyle attachment on Fix customers. Now, not only is Direct Buy disappointing from a growth perspective, but it’s also hurting the core. The company appears to be refocusing on more profitable growth around a smaller addressable market, at least that is the message near term. It has always been our contention that this model has run out of TAM far too early in its public history, hence why it has had to move from a niche curated Fix business to becoming a mass online apparel retailer. Gross margins this Q were strong due to high product margins (like everyone in apparel is experiencing) and shipping cost optimization. Freight was less of a headwind for SFIX than others due to early ordering (again, inventories were +70% at end of last qtr) in advance of the Freestyle initiative, but that freight issue is now building and the company is talking about not having a full assortment into 2H. The three growth pillars the company outlined basically suggest that it is investing to become a mass online apparel retailer. Those three pillars are: 1) strengthening customer experience with expanded inventory and product features (including 50 new brands in 2022 and a wider assortment) 2) preparing technology for scalability 3) new marketing channels like Google listings, influencer marketing, and SEO. In other words, those initiatives create more capex, more SG&A, more working capital, and more competition for customers and share. That leads to gross margins going lower, continual marketing spend, and deteriorating asset/capital returns. SFIX has lost all the special sauce of the model it established back before coming public. This company had a great model in its early pre-IPO days, but now as it chases TAM it’s become just what the tech investors don’t want to admit – a retailer. Retailers trade on earnings and cash flow. This stock is ultimately headed back to its mid-teens IPO price, and potentially lower. Best Idea Short.
