Top Pick FarFetch (FTCH) reported earnings on 11-12-2020.
As of today, we are promoting the company to a Spotlight Top Pick, from a standard Top Pick.
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 $49 in the after-hours session, up 89% in about one month.
Since this is our first earnings release with FarFetch as a Top Pick, we will allow for an extended dossier.
For those already familiar with the company, we will discuss earnings first.
Farfetch’s (FTCH) brand is its signature, and that brand is not only growing its business, it is putting the competition to shame.
This was a portion of the original bullish thesis and it has been reiterated.
The company beat revenue and earnings estimates and has guided to profitability for next quarter well ahead of schedule.
The company accelerated GMV growth to 60% in third quarter 2020 driven by acceleration across all three geographic regions – the Americas, EMEA and APAC, including each of its top 5 countries, which grew faster than during second quarter 2020.
The company has 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, the company launched a new iOS and Android app in China, providing a more localized experience for shoppers.
* Revenue: $438 million, up 71% year-over-year, versus analyst expectations of $366.94 million.
This is a big beat.
* Adjusted EPS: -$0.17 versus analyst expectations of -$0.30.
This is a beat.
* Next Quarter Adj EPS Guidance: “Positive adjusted EBIDTA” versus analyst expectations of -$0.27
This was a big raise.
The company guided Digital Platform GMV of $880 million to $910 million, representing growth of 40% to 45% year-over-year and Brand Platform GMV of $85 million to $90 million.
If we use the same take rates for the Digital Platform segment, we see 39%.
If we then apply that to the guidance of $895 million at the mid-point, we get $349 million in Digital Platform revenue.
We can add the $87.5 million guidance (at the midpoint) for Brand Platform GMV, then use the $11 million of “in-store” revenue and finally grow the $51 million in “digital platform fulfillment” revenue by the 42.5% growth in Digital Platform GMV to come up with a mushy revenue guidance of:
$349 million + $87.5 million +$11 million + $51 million*1.425 = $520 million.
That would be substantially above analyst expectations of $485.22 million.
But, let’s be careful here and not take more than the company gave us.
It’s incumbent upon us to do the arithmetic, but that’s all we did.
As for the quarter, the CEO noted:
— More metrics and analysis
* Q3 2020 Gross Merchandise Value (GMV) and Digital Platform GMV growth rates accelerated – up 62% and 60% year-over-year, respectively, to record highs of $798 million and $674 million respectively.
* Q3 2020 Gross Profit and Digital Platform Order Contribution up 82% and 98% year-over-year, respectively.
We see even more strong trends.
While GMV rose 62% yoy, revenue grew 71%. That’s due to the take rate.
We also saw general and administrative expense (G&A) hit 37% of revenue, down from 41% of revenue in the same period last year, indicating operational leverage.
We can see evidence of that same operating leverage in the adjusted EBITDA margin, which went from -19% in the same period last year to -3% this quarter and a guide to positive EBITDA margins for next quarter.
Even further, demand generation expense as a percentage of Digital Platform GMV decreased driven by incremental efficiency, less competition, and improved utilization of low-cost channels.
We can see this most clearly in a chart which plots this quarter’s expense with expenses from same period last year.
Finally, we can see technology spend as a percent of revenue dropping.
Make no mistake — this company is growing the top line and the bottom line at the same time.
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.
We note that these projections were made before COVID-19 and it is our strongly held belief that any forecast of online penetration with respect to e-commerce prior to COVID-19 simply must be rethought and reimagined.
To put it clearly, we think it will be higher, and we think it will be higher by a lot.
Here is an image shared by McKinsey which shows the 10-year growth in e-commerce penetration in the United States over a three-month period:
But we can set COVID-19 aside, for now, and just appreciate the trend that was coming anyway.
To further illustrate this trend and forecasts prior to COVID-19, we look at our final thematic chart which displays the value of online personal luxury goods worldwide from 2004 to 2019.
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.
These are the thematics we focus on with FarFetch.
Now we can discuss the company.
Farfetch Limited, through its subsidiary, Farfetch.com Limited, 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 accordingto 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.
Founder José Neves created FarFetch to be the technology partner to the luxury market with the goal of enabling access to consumers by leveraging the power of the Internet.
The company does so through the marketplace, which offers brands a direct to consumer channel and a multi brand online universe, and powers brands’ own mono-brand strategy.
That second piece is the FarFetch platform solution.
Jose went further, and developed an augmented retail solution that ties back to the entire customer journey and develops an omni-channel experience with a simple but ambitious goal — to revolutionize how consumers would interact in the stores and how sales associates would be able to leverage data from consumer interactions captured online when the consumer is in their offline stores.
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.
This includes exclusive multi brand online channels for Fenty, which is Rihanna’s brand that LVMH is building with her.
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.
In addition to Harrod’s, FarFetch operates the e-commerce businesses “for about 20 brands” — medium sized brands like Thom Browne, Emilio Pucci, Philipp Plein — well-known luxury brands that are not big enough businesses to have an entire e-commerce team behind them.
These companies leverage the solutions that FarFetch already makes available to itself, and therefore turns into the technology behind the front end of other e-commerce sites.
Given the scale of the Harrod’s win, we see the possibility that FPS could become a material contributor to FarFetch in the future, but we just don’t know enough about the firm to make that possibility an actual forecast.
I pressed on a singular issue that concerned me which is that luxury brands are very particular about owning their customer’s data and their customer’s journey, and our best guess is that they don’t like having their products and brand, the image that they’ve spent so much time and money on, sitting side by side with another brand.
In other words, luxury brands do not want to be out of control of the customer journey.
Having said that, they want to sell and being in multiple marketplaces is going to have to be a part of their sales strategy.
One of the most pleasing findings from our research was that the long-term EBITDA goal for FarFetch is 30%.
In the high technology realm, for Spotlight Top Picks we are all familiar with, we see long-term goals in the 30% – 40% range.
When we learned that FarFetch’s goal was in the bottom part of that range, it gave us comfort that long-term sustainable free cash flow (which in the limit should be the same as EBITDA) gave FarFetch a very technology feel — unlike other low margin sellers (like Amazon’s e-commerce business which runs at low single digits in the United States and negative in Europe).
About that Digital Transformation (DX)
The digital transformation (DX) due to COVID-19 is a permanent shift in the way technology is used by people, governments, and enterprises around the world.
FarFetch is not projecting that COVID-19 is a onetime event.
While this virus is a tragedy, if it happened to us ten years ago, the death toll and economic impact would have been far (far) worse.
Due to breakthroughs in technology, our medical scientists can react faster and with greater precision in an effort to vaccinate this disease.
Due to breakthroughs in technology, individuals are able to use e-commerce for nearly everything.
Due to breakthroughs in technology, the Internet can thrive under immense and sustained traffic.
Due to breakthroughs in technology, enterprises can turn a DX project from three-years into a weekend.
For all the paranoia surrounding technology, make no mistake, due to breakthroughs in technology, lives have been saved, economies have been resuscitated, and the general world order has been preserved itself while pursuing the largest, most coordinated global cooperation in the history of mankind.
So, yes, technology companies that are empowering this change, that are enabling this change, will see their stock prices go up.
FarFetch is one of these companies.
For the crew out there, that sits in incredulity at some of these stock prices, in our opinion, it would be incredulous if they didn’t rise this far this fast.
So, yeah, stuff is going to get weird in the stock market.
There has been an unnatural exogenous event that has had an unnaturalnegative impact on human kind.
In response, governments are having to act in unnatural ways to combat an unnatural systemic and human risk.
That’s not legislators being dumb or the Federal Reserve “pumping” the stock market.
It has a different name.
It’s called coordinated and forceful intellect.
It is the understanding that this unnatural disturbance requires an unnatural response.
It turns out that Fed Governors might actually know what they’re doing and sometimes, a PhD from Harvard isn’t a bad thing.
The market will have an unnatural response to this unnatural disturbance and equally unnatural intervention.
It is going to get bumpy and the stock volatility to follow is the only part of this whole thing that is natural.
When the best investors in the world hear consternation about a stock price ‘on that day that time’, they don’t hear it.
It’s not a reluctance to it, it simply means nothing.
A day cannot encapsulate the changes that have already been laid.
This understanding that whatever the market does today has no impact on the view of the future has a name.
It’s called perspective.
The rare (rare) few have it.
It is these rare few that we call the best investors in the world.
It is this group of people that you can join, by making a decision.
You are the best investor in the world with perspective.
Don’t lose it.
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.
Today we promote FarFetch as a Spotlight Top Pick.
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 calls and short puts in Farftech (FTCH) at the time of this writing.
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