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Here's Why the Best Is Yet to Come for Stitch Fix

Jeremy Bowman, The Motley Fool

In its short history as a publicly traded company, investors haven't figured out what to make of Stitch Fix (NASDAQ: SFIX). Some have dismissed it as a fad-like subscription business with similar vulnerabilities to Blue Apron, which has famously imploded since its IPO last year. Others, including myself, on the other hand, see parallels between Stitch Fix and Netflix, the data-driven streaming service that has reinvented video entertainment many times over.

Stitch Fix stock has ricocheted back and forth since its initial public offering last November. But investors cheered its recent third-quarter earnings report, as the company beat analyst estimates and posted strong growth across the board. Building on that momentum, there are several other reasons to believe the best is yet to come for Stitch Fix.

A Stitch Fix box leans against a purple doorway.

Image source: Stitch Fix.

1. New categories

Stitch Fix is still a young company. It was founded in 2011, and for most of its history it only served women in sizes 12 and under. Recently, the online styling service has begun expanding its horizons. In September of 2016, the company launched Stitch Fix Men, effectively doubling its total addressable market, and it followed that up with the launch of Stitch Fix Plus in February 2017 to serve plus-sized women. At the time of its launch, Stitch Fix Plus had 75,000 women on its waitlist.

Since both of those segments are less than 2 years old, Stitch Fix is still building them out. Its men's line sources from far fewer brands than the women's line, with about 30 brands compared to more than 250 for women.

In Plus, meanwhile, Stitch Fix has seen early signs of success. CEO Katrina Lake said on the recent earnings call that that category had already reached parity with its original women's offering in terms of orders for every shipment Stitch Fix sends.

Stitch Fix customers fill out a style profile and then routinely receive a "Fix," a sampling of clothing the company thinks they will like. They try on the clothes at home, buy what they like, and return the rest.

Stitch Fix doesn't break out sales by category, but Lake said both men's and Plus lines were key drivers of its revenue growth accelerating to 29% in the recent quarter, and called them "great additions to the business."

In addition to men's and Plus, the company is also building incremental sales through two new offerings, Style Pass and Extras, both of which were launched earlier this year. Style Pass gives its customers unlimited orders for a $49 annual fee. Extras, which is currently available only for women, allows customers to order intimates like underwear and socks directly, in addition to their (stylist-selected) Fixes. Lake also noted that enrollment in Style Pass has topped the company's expectations.

2. Untapped opportunities

In addition to the categories the company has recently penetrated, there are still plenty of untapped markets that Stitch Fix can reach. The company identified one in the recent quarterly report, saying it would launch Stitch Fix Kids. A children's line is a natural extension for the company, as its brand is particularly popular with busy moms. Through the Kids segment, the company can score incremental sales with customers who already love the service, tap into a new generation of consumers, and save parents the time and hassle of shopping for their children. The U.S. children's apparel retail market is set to reach $70.1 billion this year, so there's a huge opportunity here for Stitch Fix, especially with the launch coming just in time for back-to-school season.

Stitch Fix currently only operates in the U.S. While the company hasn't made any specific statements about when it might expand internationally, Lake dropped a hint about future ambitions on the recent call, saying, "We plan to continue growing our addressable market through expansion into new categories, product types and geographies" (emphasis mine). Apparel brands regularly find success in foreign markets as fast-fashion retailers like H&M, Zara, and Uniqlo have taken over the U.S., and Europeans and others have long coveted American labels like Levi's. Surely Stitch Fix's business model and product should be able to find an audience outside the U.S.

Additionally, there are opportunities for Stitch Fix just in improving its own business. For example, the company could offer a "rush" service for orders, as it currently takes at least a week. It could also give customers the opportunity to order some items directly on the platform, or to exchange an item with a similar one. It's also working on allowing more than five items in a given Fix, and Stitch Fix Kids offers one example of how it could do so -- Kids will ship eight to 12 items at a time. Any or all of those improvements should help increase customer satisfaction and build sales.

3. The stock looks cheap

Even after the post-earnings surge, the stock still looks cheap for a long-term growth play. Stitch Fix trades at a price-to-sales ratio of just around 2, compared to about 4 for Amazon, the dominant e-commerce company.

Unlike many start-ups, Stitch Fix has also been profitable in recent years, though it broke even last year. In the third quarter, the company reported earnings per share of $0.09. If it held that level of profitability for a year, its price-to-earnings ratio would be about 60, very reasonable for a company with this kind of growth potential.

Stitch Fix is the leading online styling service in the U.S., sitting at the intersection of two major trends in retail: e-commerce and personalization. That position alone should help the company deliver steady growth in the future, but as it ramps up new categories like men's and Plus, penetrates new markets like international and kids', and improves its own service and business model, the future could be much brighter than the market expects today.

It's up to management to execute on those opportunities, but after the recent report, it looks like more good things are in store for Stitch Fix.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jeremy Bowman owns shares of NFLX and Stitch Fix. The Motley Fool owns shares of and recommends AMZN and NFLX. The Motley Fool owns shares of Stitch Fix. The Motley Fool has a disclosure policy.