Farfetch stock: facing strong macro headwinds, competition (NYSE: FTCH)

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Investment thesis

Farfetch (NYSE: FTCH), a global luxury fashion platform, has won the pandemic as the company has benefited from the shift from brick-and-mortar to online retail. Its stock price was once up 900% from its pandemic low back in March 2020. However, the company has been caught up in high-growth stock selling, and its share price is now down more than 90% from its all-time high at the start of last year. Despite the tailwind of shifting to e-commerce which provides a huge TAM (Total Addressable Market), the company is highly exposed to the macro environment and faces fierce competition. The growth is slowing down and it is not profitable yet, which is why I consider the business to be a sale at the current price.

Farfetch is a UK based company founded in 2007 by current CEO José Neves. It aims to transform the $300 billion luxury industry through the seamless fusion of offline and online shopping and become the global platform for high-end retail. The company offers brands ranging from NIKE (NKE) to Gucci, Prada, etc. It has quite a complex business model with multiple revenue streams which include fulfillment services revenue, first party platform revenue, third party platform revenue, third party platform revenue, brand shape and in-store revenue.

To quickly explain it, proprietary platform revenue is the sales generated directly from its own inventory. Third-party platform revenue is the take rate it charges for each sale made by third-party shops on its platform. Branded platform revenue is the revenue generated under its own online brand and in-store revenue is the sales of its in-store inventory.

Farfetch

Farfetch

Market opportunity

Farfetch primarily operates in the mid- to high-end fashion e-commerce market. The market is huge and continues to grow as brands and stores move from physical retail to digital retail. The pandemic has further accelerated change, as customers can only shop online during lockdowns. According to Statista, the share of e-commerce in personal luxury goods sales worldwide is currently 10% and is expected to reach 25% in 2025, representing 2.5x growth over the period. According to Farfetch, the global personal luxury goods market is expected to grow from $322 billion in 2019 to $437 billion in 2025, representing a CAGR (compound annual growth rate) of 5%.

China is also another big catalyst for growth, as Chinese consumers’ share of personal luxury sales is expected to grow from 33% in 2019 to 48% in 2025, representing a CAGR of 11%. Additionally, since the company has a strong focus on luxury, its average ticket size is also larger than most e-commerce platforms. Farfetch is now also expanding its reach beyond fashion and into spaces such as beauty, which presents a big opportunity. These expansions allow the company to leverage its current user base and increase spending.

Stephanie Phair, CCO, on expanding beauty:

We continue to expect beauty to be an important driver of customer engagement and acquisition, enabling us to attract a new base of luxury customers and expand their share of wallet. We believe this will also help us build stronger relationships with brands.

Farfetch

Farfetch

Competition

Despite the huge TAM, the luxury online retail space is very crowded. Farfetch faces many competitors like Mytheresa (MYTE), Revolve (RVLV), The RealReal (REAL), Matchesfashion, Mr. Porter, Selfridges, Lane Crawford, etc. The problem I find in this space is that companies struggle to find a competitive advantage over others. It is essentially a perfect competition market structure where all firms offer nearly identical products and services with no barriers to entry. As a result, Farfetch has no pricing power. As a buyer myself, I have shopped on all of these websites before. I never blindly stick to one or the other of these platforms, instead, I always compare prices and go for the cheapest one. In my opinion, Farfetch needs to find a way to differentiate itself and increase brand loyalty or it will soon be overwhelmed by its competitors.

Macro-risks

The current uncertainty about the economy is likely to show significant headwinds on Farfetch, which is already showing some effect on its latest quarterly results. As a consumer discretionary business, Farfetch has significant exposure to the macro economy. As inflation continues to climb to 8.6%, consumer confidence and purchasing power are falling rapidly. The economy is weakening and companies are already stopping hiring or even firing employees. As a result, consumers are now much more reluctant to spend on non-essentials because they need to spend and save more on basics like groceries. GMV (gross merchandising volume) is likely to decline throughout the year as demand declines. The supply chain freeze also increases Farfetch’s logistics and fulfillment costs, affecting its bottom line.

In addition, the geopolitical environment linked to the confinement in China and the war in Russia/Ukraine also has a significant impact on the activity as it is strongly present in both countries.

José Neves, CEO, on Macro Headwinds:

Specifically, three key developments impacted our first quarter results and outlook. First, the war in Ukraine and our suspension of operations in Russia; second, the recent COVID-19 outbreaks and associated recessions in mainland China; and third, a double-digit decline in markdown GMV as the market’s transition to mostly full price accelerated.

Regarding China, our second market, the increase in COVID-19 cases in the context of a zero COVID policy has increasingly impacted our growth trajectory. The majority of our business in mainland China consists of cross-border sales from Europe to Tier 1 cities, such as Shanghai, which serves as a major cross-border hub. And as such, we have experienced significant disruptions in our delivery operations for the Chinese market.

Finances and evaluation

Farfetch released its first quarter results last month and it’s rather disappointing. The company reported revenue of $514.8 million, up just 6% year-over-year (YOY) from $485.1 million. Gross margin was $230.5 million, up 4.5% year-on-year from $220.1 million, while gross profit margin fell 70 basis points. The worse-than-expected revenue increase is largely attributed to the headwind the company is currently facing. GMV (gross merchandising volume) increased 1.7% year-on-year, from $915.6 million to $930.8 million.

Profitability shows no improvement, Adjusted EBITDA loss increased from ($19.5) million to ($35.8) million, an 83.7% year-over-year increase. Diluted BPA went from negative (0.28) to negative (0.37). The company posted negative operating cash flow of ($336.7) million, compared to ($282) million a year ago. This is problematic because the operating cash flow margin is now negative (65%). The company’s balance sheet is healthy with about $1 billion in cash and $750 million in debt, but it needs to find a way to improve its profitability.

Farfetch is currently trading at a FWD EV to sales ratio of 0.98 (I use the EV to sales ratio as the business is still not profitable with negative cash flow). It’s slightly cheaper than public competitors like Revolve and Mytheresa, as you can see in the table below. However, I believe the most decisive factor here is profitability. Both Revolve and Mytheresa are profitable with a forward P/E ratio in the 20s (as seen in the second chart), while Farfetch is still posting a net loss. This is essential because profitability is highly valued in times of uncertainty. Revolve is also growing faster with latest quarterly revenue up 58%, compared to Farfetch’s 6.1% increase. Therefore, I don’t think Farfetch’s valuation is attractive relative to its peers.

Chart
Data by YCharts
Chart
Data by YCharts

Conclusion

In conclusion, I think there are currently too many problems surrounding Farfetch. The company has a large TAM with tailwinds from moving from brick-and-mortar to online retail, but it also faces plenty of competition. Most of its competitors are able to offer similar or even identical products and services, which reduces Farfetch’s pricing power. More importantly, the business faces headwinds from the macro environment. This includes the Russian-Ukrainian war, the lockdown in China, high inflation and a weakening economy. This is having a significant impact on the company’s performance, as its latest quarterly results show. I believe these headwinds will persist and continue to weigh on business performance. The current valuation is also not attractive compared to its peers which are profitable and growing faster. Therefore, I think Farfetch is selling despite the stock down more than 90% from its all-time high.

Martin E. Berry