This Stock’s Big Rally Isn’t Over Yet

Shares of Stitch Fix (NASDAQ:SFIX) soared on Tuesday after the personalized e-commerce retailer reported second-quarter numbers that smashed expectations across the board. Management also hiked the fiscal 2019 guide to far above consensus levels. The double whammy of good news was celebrated by investors, and SFIX stock popped more than 25% in response.

To be sure, this is a recovery rally in SFIX stock. About six months ago, this was a $50 stock. Back-to-back disappointing quarters in late 2018 depressed investor sentiment and led to a bunch of selling.

SFIX stock dropped to $16 in December.

Now, thanks to financial market stabilization and strong second quarter numbers, SFIX stock is clawing its way back.

There are two ways to look at this recovery rally.

On one hand, you have a momentum stock that has more than doubled in just over two months and is technically overbought.

On the other hand, you have a growth stock that is still more than 30% off its all-time highs and remains fundamentally undervalued.

Which way should you look at it? The latter. Sure, SFIX stock has come very far, very fast. But, in the bigger picture, Stitch Fix is still in the early innings of changing the way the retail world works. As the company continues to pioneer this change over the next several years, the customer base, revenues, margins, and profits will all grow by leaps and bounds. That growth will power SFIX stock higher.

In other words, this is a long-term winner clawing its way back. How much higher can SFIX stock go? My numbers suggest a 2019 price target near $40, and a long-term price target upwards of $60. Thus, at $30 and change, SFIX stock still has more upside left in both the medium and long term.

Strong Q2 Numbers Underscore Secular Growth Narrative
In many ways, the post-Q2 pop in SFIX stock is a byproduct of the post-Q1 drop.

Back in early December, Stitch Fix reported strong Q1 numbers that were accompanied by a weak Q2 guide. Specifically, Stitch Fix said that the client base wouldn’t grow during the holiday season as the company pulled ad spend during a seasonally low add quarter. They also said that EBITDA margins would get hit hard by inventory clearing and strategic investments. SFIX stock dropped big in response.

I said buy the dip because the holiday-quarter headwinds were temporary and overstated. The Q2 report affirmed that they were both. It was a big double beat quarter that included client base growth, accelerated revenue growth, big gross margin expansion, and much bigger EBITDA margins than anyone expected (5.2% EBITDA margins versus a guide that had pegged EBITDA margins below 3%). Perhaps more importantly, management hiked its full-year 2019 revenue and profit guides in a big way to account for better-than-expected growth and margin performance.

In other words, all those headwinds that plagued SFIX stock in late 2018 (slowing growth and falling margins) are reversing course. As they reverse course, the long term bull thesis is gaining clarity.

That long-term bull thesis is fairly simple. Stitch Fix is dramatically improving the shopping model by leveraging data, technology, personalization, and curation to improve customer outcomes, lower costs, boost convenience, and save time. Given these consumer advantages, it’s only a matter of time before the Stitch Fix model becomes widely adopted throughout the global apparel market. That market measures $1.7 trillion globally. Revenues last year at Stitch Fix were around $1.2 billion.

Thus, this is an innovative, big-growth company with secular advantages and a huge opportunity in front of it. Investors are starting to buy back into that bull thesis. As they do, SFIX stock will only head higher.

Long-Term Upside Is Promising
The math underlying SFIX stock is pretty simple.

This is a $1.2 billion revenue company attacking a $1.7 trillion global market. Growth rates are north of 25% and not slowing. The customer base continues to grow at a big 15%-plus year-over-year rate. Gross margins are trending towards 45%. Opex rates aren’t falling, yet, but they should head towards management’s long term target of 35% within the next several years.

Overall, given healthy fundamentals and the huge opportunity, Stitch Fix will likely remain a 15%-plus customer grower with 20%-plus revenue growth rates over the next several years. Gross margins will stabilize around 45%. Opex rates will fall towards 35%.

Putting all that together, I think a reasonable EPS target for Stitch Fix by fiscal 2025 is $3.15. Based on a growth average 20 forward multiple, that equates to a fiscal 2024 price target for SFIX stock of $63. Discounted back by 10% per year, that equates to a fiscal 2019 price target of nearly $40.

We are halfway through fiscal 2019, and SFIX stock is still south of $35. Thus, upside in both the medium and long term looks healthy from here.

Bottom Line on SFIX Stock
In the big picture, Stitch Fix is in the early stages of pioneering a new and improved shopping model across the global retail apparel market. That market is huge. Stitch Fix is not huge. Thus, the company has a tremendous opportunity in front of it to keep growing at a big rate for a lot longer. When investors believe in that long term narrative, SFIX stock rises. When they don’t, SFIX stock drops.

A strong beat-and-raise second quarter gives investors plenty of reason to believe in the long term narrative. This bullish sentiment will hang around for a little while longer. So long as it does, SFIX stock will stay on an uptrend.

— Luke Lango

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Source: Investor Place