Farfetch: Long Runway And Cheaply Valued (NYSE:FTCH)

Investment Thesis

Farfetch (FTCH) is a leading luxury fashion platform. It’s growing its top aggressively while keeping an eye on its bottom line.

As I’ve been making the case to Deep Value Returns Members, even though luxury shopping should be struggling in the COVID environment, as consumers have fewer outings, Farfetch continues to grow its top line at more than 70% y/y.

Even we assume a dramatic deceleration in revenue growth rates for 2021, where Farfetch could see its top line grow at just 35% y/y, the stock is still being priced for just 9x forward sales — an impressive investment opportunity for investors.

(Source)

Very Strong Growth Rates, With No Signs of Slowing Down

I haven’t missed the fact that the stock is up 50% in the past month.

Let me make it absolutely clear, it makes no difference over the next two to three years, what the stock has done. What matters is what the stock will do.

There’s always going to be some short-term unpredictable movements, but don’t let them anchor you. One should always attempt to understand the opportunity ahead, not what happened in the past.

Source: author’s calculations

On the surface, Farfetch’s Q3 2020 results were impressive. There’s no point discussing them too much — it was a faultless quarter.

But its guidance had some issues, which I believe should be analyzed. Farfetch’s GMV was up 62% y/y in Q3 2020, but it’s pointing towards 43% y/y for Q4 2020. This is quite a dramatic deceleration from one quarter to the next.

Management noted that Farfetch is now attempting to position itself for sustainable growth and it is coming away from its reliance on promotional incentives, and attempting to grow its bottom line as well as its top line.

Also, during this upcoming Q4 we know that in this COVID environment, there’s less need for luxury shopping. After all, where’s the customer going to wear their expensive merchandise?

But I strongly recommend investors to look further ahead beyond the next 90 days and to consider what the next two to three years will bring for Farfetch.

Brand Platform: Bad News and Good News

Looking back to last year, Farfetch’s Brand Platform GMV was $102 million in Q4 2019. Whereas in Q3 2020 it was $112 million in GMV. Consequently, its guidance for Q4 2020 implies a drop-down towards the midpoint of $88 million, and this is somewhat odd and not aligned with its high growth story. However, this is just a single quarter.

On the other hand, we should bear in mind, that Farfetch’s Brand Platform carries high adjusted gross profit margins of 52.3%, above Farfetch’s corporate average of 47.8%.

Having said that, Farfetch’s Brand Platform contributes 36% towards the group’s gross profit, so it’s not the whole story for Farfetch, but it is worthwhile to bear in mind.

On this note, Farfetch makes the case that it is now going to reduce its promotion activity, and that during Q3 2020, Farfetch had 70% fewer promotional days and that it intends to embark into Q4 with even fewer promotions.

At the same time, Farfetch notes that Q4 of this year, competitors will be incredibly promotional, with its competitors having to unload merchandise. Thus, this festive season will be quite a difficult one for Farfetch.

Nevertheless, Farfetch still expects to reach record revenues, and its GMV on its Digital Platform will be up roughly 43% y/y to $900 million.

Path to Profits Starting This Next Quarter

Moving on, Farfetch’s adjusted EBITDA was negative 15.6% in Q3 2019, and it now improved to negative 2.7%. Furthermore, Farfetch notes that it expects to reach adjusted EBITDA profitability in Q4 2020, and that for 2021 it will also reach adjusted EBITDA profitability.

However, Farfetch declares that 2021 will not see positive adjusted EBITDA results in every quarter, but that for 2021 as a whole it will be EBITDA positive.

The Amazon Threat: Putting Investors’ Concerns to Rest

Many investors were worried that Amazon (AMZN) would prevent any potential for Farfetch to come along and grow scale. Amazon is certainly a formidable adversary to any online business.

On the one hand, that sounds true enough to bring validity to the argument. However, high-end businesses, think Dolce & Gabbana or Ralph Lauren (RL) will do whatever it takes to prevent Amazon from becoming too big, and would much prefer to join forces with Farfech rather than listing their luxury merchandise on Amazon.

Indeed, if anything, purchasing your luxury merchandise off of Amazon would cheapen the whole experience.

What’s more, the fact that two of Farfetch’s competitors, Alibaba (BABA) and Richemont (OTCPK:CFRHF), will have a joint venture where Farfetch will own 75% with the remaining 25% being owned equally by Alibaba and Richemont, speaks of the growing importance of Farfetch.

Valuation — Why This Stock is Cheaply Valued

Assuming that Farfetch’s revenues growth rates decelerate into 2021, so that’s revenues grow by 35% y/y compared with the impressive 60% investors are expecting in 2020, that would put Farfecths’ revenues at $2.2 billion.

Presently, this would mean that Farfetch’s revenues are priced for close to 9x forward sales. I know that Farfetch is not a SaaS business, with recurring revenues and very high-profit margins, but 6x sales strike me as unreasonably cheap.

For example, LVMH (OTCPK:LVMUY) and Tiffany (TIF), both these companies are trading for approximately 4x forward sales while Farfetch trades for slightly more than 9x forward sales. However, those two peers are nowhere near as successful with their online penetration. Also, those companies are growing at approximately 20%, whereas Fartech is growing substantially faster, even if we assuming its decelerating growth rate.

The Bottom Line

Farfetch is not a renowned household e-commerce site. However, it is certainly growing at a strong clip, and while it’s reducing its dependency on promotional activity, it’s not slowing down.

Despite having a lot of competition, bigger competitors are preferring to join forces with Farfetch rather than competing with the e-commerce platform.

I’m a huge fan of investing in founder lead companies, such as Farfetch, where the CEO has a lot of skin in the game and thus is highly incentivized to maximize shareholder value.

Investors will do well to consider this investment.

PRICE HIKE COMING JAN. 2021!

After a very strong 2020, Deep Value Returns will be increasing its prices for new Members.

Don’t PROCRASTINATE.

Disclosure: I am/we are long FTCH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.