By now it has become relatively clear that the world is heading towards some form of recession: the only question is how far it will be. Discretionary spending categories, especially on products like luxury goods, have already started to see strong quarter-over-quarter growth down, and many of the hottest internet/e-commerce consumer stocks during the pandemic have become huge eyesores in our portfolios.
Farfetch (NYSE: FTCH) is a clear example here. This luxury e-commerce company has lost 75% of its value since the start of the year, as the company continues to release a dollop of bad news with each quarterly earnings release. The company will then report its earnings in mid-November and, to say the least, confidence in the stock is quite low.
Despite the stock’s recent downtrends, as well as the virtual certainty that the last two quarters of FY22 will likely prove quite bleak for Farfetch, I believe most of the risks are now well known and taken. into account in the action, and I’m moving my rating on Farfetch to neutral. I’m just of the view that investors will soon tire of indiscriminately selling e-commerce stocks, and with valuations and fundamental expectations for these stocks at multi-year lows, I think companies like Farfetch have the potential to bounce on the slightest whiff of good news.
Of course, there are major red flags here and risks to consider:
- China could be at the forefront of the global recession. Consumer confidence is down in the world’s largest economy (which is an outsized buyer of luxury goods, needless to say), and further COVID resurgences won’t be Farfetch’s favor either.
- Major Headwinds FX. Much of Farfetch’s revenue is international, resulting in significant dollar exchange losses.
- How long will it take for the luxury category to recover? If a global economic recession drags on, it may take a long time for the luxury category to rebound. On the contrary, post-pandemic trends have shifted towards more relaxed and casual clothing, and a poorer global population may have a lower propensity to spend on unnecessary luxuries.
That being said, I don’t think it’s all bad for Farfetch; in particular, I think investors should consider a few “saving graces”:
- Farfetch is pretty well capitalized for a denial. The company has $1.47 billion in cash on its most recent books, and even after removing $515 million in debt, it still has nearly $1 billion in net cash. That’s a lot of financial flexibility to weather a downturn, especially since the company isn’t printing huge losses (its Adjusted EBITDA margin is about flat).
- Gross margins are holding up. As Farfetch reduced its reliance on demand generation and promotional activities, the company was able to maintain its gross margin profile even in this inflationary environment.
The bottom line about Farfetch: it’s not my first investment choice in a very choppy market. I would rather buy an enterprise software company that is also battered but has recurring contract revenue. At the same time, given Farfetch’s sizable net cash position (which is about a third of its current market value), its proven niche in the luxury e-commerce market that not even Amazon (AMZN) has failed to penetrate, and from a relatively healthy margin/EBITDA profile, I’d put this one on a watch list.
Let’s now briefly review the highlights of Farfetch’s last quarter. Although investors have understood the turnover risks very well, there are also some positive announcements that are worth mentioning. The second quarter revenue summary is shown below:
As noted above, Farfetch’s GMV – the most watched metric for the company, as it is for all other e-commerce business – grew at a meager rate of 1% per year, decelerating slightly compared to the 2% growth per year of the first quarter. assess. This is due to both a reduction in consumer spending and heavy currency impacts. On a constant currency basis, the company would have seen stronger growth of 8% year-over-year. The company’s third-party digital platform saw a decline in growth, as shown, while the company’s own brands saw rapid growth of 47% year-over-year, due to the brands’ strong customer reception. Off White and Palm Angel of the company. Growth here was also partially driven by a catch-up and recovery from a warehouse issue in the first quarter. In-store revenue also increased 39% year-over-year.
The good news that offsets the full GMV deceleration here is that revenue grew 14% YoY, which actually accelerated from the 7% YoY pace of the first quarter. This is due to the greater revenue weight of the faster growing branded platform as well as the higher participation rates of the digital market. The company also kept its active customer base stable in the first quarter and up 13% year-on-year to 3.8 million.
Margins were another major win for the quarter. The company’s overall gross margins actually increased 220 basis points to 46.2%. This was primarily driven by improved brand platform margins (up six points year-on-year), which also contributed more to revenue this quarter.
And while Farfetch has also seen operating expense inflation alongside many other companies, the three-point increase in general and administrative expenses was almost entirely offset by a two-point reduction in technology spending. As a result, Adjusted EBITDA margins remained stable at -5% for the quarter:
Key points to remember
In my opinion, this is not a pure disaster story for Farfetch. I believe that the health of the company’s proprietary brands, its relatively stable margin profile and its large cash balances will help it weather the current recession. At the same time, the timing of the recovery in the luxury market and the fact that Farfetch’s revenues are heavily concentrated in China and Europe (whose currencies have depreciated sharply against the dollar) pose major risks. I would say stay away here, but at the same time Farfetch doesn’t have much room on the downside.