Stitch Fix stock falls as much as 28% on fears that its new service could ‘cannibalize’ its core business

December 8, 2021, 7:22 PM UTC

Stitch Fix, the online styling service and apparel seller, is trying to refashion its own look. But Wall Street fears its latest financial results suggest it might not be able to pull off the makeover quickly enough, and investors sent the one-time tech darling’s shares into free-fall on Wednesday.

The San Francisco-based company made its name by using algorithms, complemented with human stylists, to send customers clothing and shoe items that Stitch Fix chooses for them, on a recurring basis set by the customer. But as time has worn on, Stitch Fix has sought to spur new growth by allowing consumers to buy clothes and shoes they choose themselves, as they would at any other online retailer, with an option called Freestyle. That service is now available to the broader public after initially being limited to Stitch Fix clients.

But Stitch Fix shares tanked as much as 28% in early trading Wednesday, as analysts saw reasons to believe growth in that new service might not be as robust or come as quickly as hoped for and might even hurt Stitch Fix’s core business. To be sure, quarterly revenue came in a hair above forecasts, and the company saw improvements in customer retention and more spending per active client.

Despite that, the company offered ample reason for caution. Stitch Fix noted that the number of new clients over the prior quarter—just 15,000—was lower than in previous quarters, and the company lowered its fiscal-year outlook for revenue growth. StitchFix now says it expects revenue to rise by a high-single-digit percentage, well below the prior forecast for 15% growth or better, citing the need to be “conservative” while it fine-tunes Freestyle.

Elizabeth Spaulding, a former management consultant who became CEO in April after succeeding Stitch Fix founder Katrina Lake, sounded a note of caution on a call with investors about how quickly Freestyle would catch on, and she recognized the paltry number of new clients Stitch Fix added last quarter. Spaulding is placing a big bet on Freestyle, seeing it as the cornerstone of what she calls Stitch Fix 2.0., looking to win customers who might prefer final say on what they buy.

“We are in a major learning phase right now as we build out our new Freestyle experience,” Spaulding told listeners on a conference call late Tuesday. Her thesis is that Freestyle could help Stitch Fix build market share in product categories such as footwear, dresses, outerwear accessories, and loungewear that aren’t all that common in “Fixes,” the boxes of items Stitch Fix chooses for a customer.

But the challenge for Stitch Fix is that consumers have countless options for simply buying clothes they want on demand. To distinguish the company from the sea of online apparel sellers out there, Spaulding is betting that tech that allows Stitch Fix to choose items for clients’ Fixes will also be effective in suggesting items with better odds of success with customers looking to choose and buy things themselves.

“Everything we show each client is unique to them and reflects what will best fit their body, represents as well as pushes the boundaries of each client’s personal style and provides value-added features, such as algorithmically generated outfits,” she said.

Yet Spaulding herself acknowledged the risk of “short-term cannibalization,” particularly among newer customers. Analysts agree: “Stitch Fix will need to monitor how shoppers move between the subscription and Freestyle models,” Neil Saunders, managing director at GlobalData, wrote in a research note.

Uncertainty on when the reinvention would yield big revenue gains made some investors and analysts fearful about Stitch Fix’s prospects. BMO Capital, Canaccord Equity, Telsey, Evercore ISI and Wells Fargo were among the slew of Wall Street firms that lowered their price target for Stitch Fix’s stock since Tuesday’s earnings call. “Our call is that Stitch Fix has hit a growth wall,” Evercore ISI wrote in a research note.

What discomfited a number of analysts was that Stitch Fix’s struggles come at a time apparel sales in the U.S. are booming: Everyone from Macy’s to Target to Abercrombie & Fitch has reported strong apparel sales this autumn. And the concern is that Stitch Fix isn’t fully taking advantage of the pent-up demand for new clothes that is propelling industry-wide gains. So now, Wall Street is back in “show-me” mode with a once favored stock.

“Unfortunately, in our view, this puts the model into question,” Wells Fargo wrote in a research report.

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