Farfetch Is an Underappreciated Growth Story -CML

Spotlight Top Pick FarFetch (FTCH) reported earnings on 5-13-2021.

As a Spotlight Top Pick, this places FarFetch in the second circle of this logic diagram:

We added FTCH to Top Picks on 10-01-2020 for $26.00.

As of this writing, it is trading at $37.24 in the after-hours session, up 43% in about seven-months but down 42% YTD.

Before We Talk…
There are two phenomena surrounding Farfetch that we should discuss up front.

First, with so much of the bullish thesis focused on China, as you will read below, this company will never be a numbered Spotlight Top Pick. It’s just a rule I have in my mind about risk.

Having said that, please don’t let semi-arbitrary labels govern too much of the value you extract from our research. If a company is a Top Pick of any flavor, we feel bullish about.

There will usually be our ‘speculative’ investments, like ONDS, CURI, and now NVTA, but it takes a lot for a company to meet the criteria to make our list, so please, enjoy the research and use your own discernment to rank them as you feel best fits your world views.

The second phenomenon surrounding Farfetch is not so dissimilar to other Top Picks, but maybe a bit ‘hyper’ on this one reality.

Analysts just didn’t believe in the company in the past and while that incredulity has ebbed as the years have followed, there is still a general undertone of ‘Luxury e-commerce retail…really? That’s your business? That’s your moat?’

The best way to put numbers (and therefore a chart) to this incredulity is to look at how consensus revenue estimates for 2021 revenue have moved over time.

Here’s a chart, first, and then some words:

These are how the consensus estimates for 2021 revenue for Farfetch have changed since 10-2018.

So, in 3.5 years, the estimate for 2021 revenue has gone from $1.2B to $2.2B or 80% higher.

This is incredulity in a chart.

It does not mean, now, that 2024 estimates are somehow 80% too low, please don’t go there.

It does mean that analysts have had a history of under estimating Farfetch’s ability to capture a massive market (discussed below).

Now, onto our story…

Preface
Our last quarterly review of Farfetch was rather holistic. We will use portions of that dossier moving forward, but leave much of the detail there as we look forward.

For reference, we do encourage a read of: FarFetch Aims To Be Winner Take All.

Story
Two quarters ago Farfetch beat expectations and delivered a profitability guidance that was simply not conceived of by any analysts — not even close. We detailed that in the prior dossier.

But we noted that two phenomena imposed their will on the stock market, both of which are urgent in the very short term but less so, if at all, in the medium to longer term.

First, based on the results from Spotlight Top Pick Shopify (SHOP) and FarFetch (FTCH) (last quarter) as well as niche e-commerce wunderkind Etsy (ETSY), all of which truly obliterated estimates, institutions are not ingesting the numbers as though they are representative of the future.

The stocks are being treated as if this was a one-time event.

We said that time will tell if this is appropriate, and today we get a look at one quarter, with dozens more to come.

The second phenomenon is the fear of reflation.

We’ll just keep repeating this until the full community has been exposed to it.

There will be a narrative that will soon be prolific, that focuses on the dual headwinds for technology companies of reinflation and the end of COVID.

With Farfetch, though, we have a third leg to the story — China.

As you will read, Farfetch has a fabulous position in China — unusually strong for a non Chinese brand.

We got news from Alizila, which is Alibaba’s for-profit news outlet, that Farfetch has launched its Luxury Pavilion.

Here’s a snippet:

Farfetch officially debuted its digital store on Tmall Luxury Pavilion on Monday – a move that drastically expands the range of products available to millions of shoppers on the Alibaba-owned platform for luxury and designer brands.

Then we got a rather warm reaction from the General Manager of Tmall Luxury Janet Wang when she said:

The launch of the Farfetch Tmall flagship is a very exciting moment for China’s booming online luxury market.In partnership with Farfetch, we will continually enhance our product selection, marketing strategies and membership services for our consumers. We aim to set the standard in the industry and lead the digitization of luxury shopping.

Source: Alizila (Alibaba’s news outlet)

Farfetch will likely increase marketing expenses for the full year of 2021, but for good reason. As far as we can tell, no analyst on Wall Street has modeled any revenue for 2021 from this massive China opportunity — which means we see substantial upside.

For the record, Alibaba has 779 million shoppers, although not all of them are luxury targets.

We detail the opportunity in China further in the sections to come.

Now, either all of that is bullish for you — seeing the exuberant growth in e-luxury in China, or it is bearish for you — the risk of a sudden change by China with respect to outside firms.

That final point is for you to decide and we’re not sure any kind of analysis of earnings will help. It’s a bigger question that spans well past a quarter.

Now we turn to earnings.

Earnings
We said for the first time, two quarters ago, that we believe this company may in fact end up being the winner takes all (or winner takes most) e-commerce platform for luxury — an idea which was simply inconceivable just one year ago.

After all, the luxury market is dominated by brands and it just cannot be that a platform can command as much power as these brands, either one-by-one and certainly not in total.

Two quarters ago we wrote that Farfetch’s (FTCH) brand is its signature, and that brand is not only growing its business, it is putting the competition to shame.

Now we turn to Q1 results.

Two quarters ago the company announced a global partnership with Alibaba and Richemont to accelerate the digitization of luxury industry.

The strategic partners will invest a total of $1.15 billion in Farfetch Limited and the new Farfetch China joint venture.

The new China joint venture to be formed to operate the Farfetch marketplace in China is to be 75% owned by Farfetch, with the remaining 25% owned equally by Alibaba and Richemont.

These are all enormous numbers.

Even further, last quarter the company launched a new iOS and Android app in China, providing a more localized experience for shoppers.

And, again, they are either very bullish for you, or they are very concerning and nothing we write about the quarter just reported will change the impact of that statement.

Now to the quarter just reported:

* Revenue: $485 million, up 46% year-over-year, versus analyst expectations of $458.79 million.
This is a beat.

Gross Merchandise Value (GMV): $915.6 million, up 50% year-over-year, versus analyst expectations of $872.3 million.
This is a beat.

Digital Platform GMV: $790.0 million versus analyst expectations of $753.3 million.
This is a beat.

Average Order Value (AOV): $618 million versus analyst expectations of $548 million.
This is a beat.

Brand Platform Revenue: $112.3M vs versus analyst expectations of $100.4 million.
This is a beat.

Digital Platform Fulfilment Revenue: $76.2M versus analyst expectations of $58.1 million.
This is a beat.

Active Consumers: 3.27 million versus analyst expectations of 3.00 million.
This is a beat.

* Adjusted EPS: -$0.22 versus analyst expectations of -$0.26.
This is a beat.

* Adjusted EBITDA: -$19 million versus analyst expectations of -$20.2 million.
This is a beat.

But, there were some misses as well.

First, from the quarter reported.

Digital Platform Services (DPS): $285.9M versus analyst expectations of $302.8 million.
This is a miss.

You will note that DPS accounted for 59% of revenue, but further, if we use the estimates Wall Street was expecting 302.8/458.79 or 66% of revenue, the miss was larger.

DPS is the higher margin side of the business, so in a sense, while Farfetch delivered huge numbers, someone could argue that the company beat in the wrongplaces.

Digital Platform Order Contribution: 33% versus company guidance of 32%-34% three-months ago and analyst expectations of 34.5%.
This is a miss.

Next quarter total GMV comes from Digital Platform ($925 million at the midpoint) and Brand Platform ($55 million at the midpoint) totaling $980 million.

If we use the same take rate as Q1 and apply it to Q2, then…

* Next Quarter Revenue Guidance: $519.5 million versus analyst expectations of $524.5 million.
This is a miss.

(This has a pretty big assumption baked in which may not be accurate enough to measure down to a 1% ‘miss.’)

Next quarter Adjusted EBITDA of -$24 million at the midpoint gives us….

* Next Quarter Adjusted EPS Guidance: -$0.28 versus analyst expectations of -$0.23.
This is a miss.

(This assumes the same number of fully diluted shares as of March 31, 2021 which may be in accurate.)

But, the EBITDA miss for Q2 is far less important when taken in the context of a repeated, but still crucial, statement (our emphasis added):

In light of the continuation of this strong momentum against a more favorable consumer backdrop, we are even more optimistic about our growth expectations for the year, and the value in continuing to invest behind our long-term growth opportunities as we continue to focus on delivering our first full year of adjusted EBITDA profitability 2021.

That’s it; nobody cares about Q2 adjusted EPS if the company delivers full year profitability.

— More metrics and analysis
I don’t know how many analysts are going to go this far, but FarFetch offers quite a bit of data so let’s do it.

For all of 2020 we saw:

* While ‘Group’ GMV was up 48.9%, ‘Group’ adjusted revenue was up 63.6%.

* While ‘Digital Platform’ GMV was up 41.7%, ‘Digital Platform’ adjusted revenue was up 47.3%.

This feels like higher take rates.

* For Q1 2021, we also see that demand generation expense as a percent of Digital Platform GMV stayed steady at 8%.

* For Q1 2021, further, demand generation expense as a percent of Digital Platform Services revenue stayed steady at 22%.

* In Q1 2021, we also saw general and administrative expense (G&A) hit 35% of revenue, down from 37% of revenue in the same period last year, indicating operating leverage.
(We expect this leverage to worsen in Q2 and resolve for the full year.)

* For Q1 2021, technology spend expense as a percent of revenue hit 14%, down from 16% in Q1 2020, indicating operating leverage.

We can see the final result of that same operating leverage in the adjusted EBITDA margin, which went from -7% (negative) to -5% year-over-year in Q1. For the full year, we except to see a positive number here, so more operating leverage.

If we look at all of 2020, we get an adjusted EBITDA margin improvement from -14% to -3% and we now have guidance that for full year 2021 that number will be positive 1% – 2%.

Make no mistake — this company is growing the top line at 46% year-over-year in Q1 while the adjusted bottom line saw losses shrink and full year guided to a profit.

Analysis
This is all very good, and yes, the highest margin portion of the business came in a little soft (while others did better), but if we back out from the quarter-to-quarter minutiae, Farfetch is winning in a very big market showing substantial growth and growing operating leverage.

We can use Etsy as a sort of comparable since it is an e-commerce platform that doesn’t have a strong software as a service arm.

Etsy has analyst estimates for 25%, 20%, and 23% revenue growth for 2021, 2022, and 2023 respectively and an EV to 2023 sales ratio of 6.1.

Farfetch has analyst estimates for 33%, 28%, and 32% revenue growth for 2021, 2022, and 2023 respectively and an EV to 2023 sales ratio of 3.3.

So, about half the valuation and substantially higher growth.

Now, yes, Etsy is profitable, so that deserves a premium, but Farfetch has guided to profitability this year, and we see the enterprise as underappreciated.

We also have seen a long history of under estimation in revenue forecasts for Farfetch, yielding a result from the analysis above that points to further underappreciation.

Finally, we must note that on the one hand Farfetch is global, and on the other, ya know, China…

We’re bullish and respect the risks moving forward. That’s it.

Snapshot
In the following section with a few images and about 25 sentences, you will have our bullish long-term thesis.

This is shorter than the prior review snapshot so not to become too repetitive.

Farfetch provides an online marketplace for luxury goods in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.

The company operates in four segments: Farfetch Marketplace, Farfetch Black and White, Farfetch Store of the Future, and Browns Stores.

It operates Farfetch.com, a Website and mobile app for luxury goods; and offers Farfetch Black & White, a white-label business to business e-commerce solution with front-end suite of products comprising Websites and apps for retailers and brands.

The company takes a 25% commission per sale from its boutique partners and an additional fee of up to 8% if it handles the fulfillment and shipping.

That also means it carries virtually no inventory risk since it does not own the products.

The company does have an accelerated China strategy which is a monstrous opportunity not just due to the size of the Chinese market, but in particular with China’s GDP back to growth as COVID has nearly drifted away.

The Chinese luxury market, in and of itself, will stand at $170 billion according to FarFetch, by 2025.

FarFetch’s success depends largely on its own brand acting is its signature in a world where brand is everything. This is not a triviality and it will be tested by competitors.

But, for now, yes, FarFetch’s brand is a clear asset.

The company was created to be the technology partner to the luxury market.

The technology platform, is meant to be multi-tenant. It supports the FarFetch marketplace, which is the central B2C (business to consumer) solution and it also powers the B2B (business to business) solution, where the company leverages that same technology to power similar solutions for other parties within the luxury industry.

The company differentiates itself by attempting to deliver the most compelling experience and the most compelling selection for consumers. That’s the broadest selection of luxury fashion, with the largest audience, delivering an online and a multi brand channel of luxury fashion consumers.

The company goes further to offer unique content — meaning it is unavailable elsewhere.

This content comes through the brand portfolio under NGG (New Guards Group) but also in working with the brands to help then create capital that is exclusively available on FarFetch.

If you go to the FarFetch site, from time to time the company offers exclusive capital, where brands will create designs, unveil new products in their collections and they will make them exclusively available online to FarFetch consumers.

While the brand platform solution sounds like ‘Shopify for luxury,’ when we asked if it was a material contributor to revenue, the answer was essentially, “not yet.”

The company does not report Farfetch Platform Solutions (FPS) separately from the rest of the digital platform.

The company did note to us that in 2020 FPS has become a significant step forward in the business because it launched Harrod’s (a leading luxury department store in the UK which offers over 5,000 brands.)

Harrod’s is a multi-billion-dollar overall department store, but has not broken out what portion of business is online.

The Harrod’s partnership came online 2020, so this could be seen as a significant step forward in the overall contribution from the FPS business.

As for thematics, the worldwide retail luxury market is enormous.

Revenue from luxury goods was $213 billion in 2012 and is forecast to reach $388 billion by 2025.

In the chart below from Statista, we can see the remarkable trend, even when accounting for the impact of COVID-19 in 2020.

But, while that trend is strong, there is yet more growth when we see the transition of revenue going to online.

In this next chart from Statista, we see that online penetration of global luxury good sales will rise massively from 10% in 2018 to 25% by 2025.

Now, look at this change — we are going to compare total luxury buying versus online luxury buying and this will be hard to believe.

Now we can see this impact on the thematic pressing FarFetch forward in the chart below via Statista.

Online personal luxury good sales rose from 1.1 billion Euros in 2004 to 33.3 billion in 2019, for a 33-fold rise.

The number rose 50% from 2017-2019 and showed signs, already prior to COVID-19, of continued growth.

But what happened due to COVID was massive.

Growth from 33 billion Euros in 2019 to 49 billion Euros indicates 48% growth in a single year, nearly equaling the percent growth rate for the three years from 2017-2019, and in nominal terms showing 16 billion Euros growth in a single year versus 16 billion Euro growth over the prior five years.

Yes, the digital transformation (DX) moved the industry up 5-years in one year.

These are the thematics we focus on with FarFetch.

Now we can discuss the risk.

Risk
The risks for FarFetch are numerous.

* While the company is a leader in the online luxury market as an aggregator, others exist and new comers may pose a threat to their 30% long-term EBITDA goal. As competition “comes”, so too do margins “go.”

* Even as the company presents clear value to brands, never under estimate the power dynamic between the brand and the third-party platform that hosts the brand. In our opinion the aggregation of luxury goods is not only obvious, it’s a growing thematic, but we could be wrong and there is no FarFetch without brands.

* The company is not yet cash flow positive and while it has a goal of cash flow breakeven by 2021, that’s just a goal, it has not been proven out.

* COVID-19 is still a real threat. It has decimated world economies which have been equally resilient in the near-term, but the totality of the economic impact from the virus is not known. It just isn’t.

* The relationship between China and the United States is tenuous and we don’t know what that means for FarFetch.

Conclusion
Today we maintain our Spotlight Top Pick status on FarFetch (FTCH).

Its moat is real, but could be perceived as tenuous.

It sits in a massive thematic (luxury goods sales) while leading a faster growing segment of that thematic, which is e-commerce.

We see e-commerce in general booming forward, striking levels even higher than current forecasts.

If FarFetch executes as it has in the past and plans to do for the future, it has large opportunities in front of it.

Its success depends largely on its own brand acting is its signature in a world where brand is everything.

Thanks for reading, friends.

The author is long shares of Farftech (FTCH) at the time of this writing.

The author is long call spreads and short put spreads in Farftech (FTCH) at the time of this writing.

The author is long stock in Shopify (SHOP) of the other companies mentioned in this dossier at the time of this writing.

Please read the legal disclaimers below and as always, remember, CML Pro does not make recommendations or solicitations for the sale or purchase of any security ever. We are not licensed to do so, and wouldn’t do it even if we were. We share research and provide you the power to be knowledgeable to make your own decisions.

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