Farfetch’s (NYSE: FTCH) uncontrollable spending spree has rattled investors, sending shares to all-time low levels. This is despite the luxury industry’s resiliency, which has helped the company maintain robust top-line revenues.
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Admittedly, Farfetch owns a fantastic merchandise platform tech-wise and some iconic fashion brands, including Off-White, which should bolster growth once the ongoing market distress decompresses.
Nevertheless, the company doesn’t seem to be able to control the cash outflow tap, while its excessive stock-based compensation levels continue to dilute investors by the quarter. Accordingly, I am neutral on the stock.
Resilience in Luxury Industry Drives High Product Demand
Contrary to what some may think, the luxury industry is highly resilient, which keeps driving high traffic in Farfetch’s marketplace and demand for its brands. Sure, a tough macroeconomic environment is supposed to reduce consumers’ purchasing power, but when it comes to high-end products and affluent consumers, the “laws of physics” don’t apply likewise. Wealthy consumers are usually hardly affected during tough economic times. If anything, tough times present fruitful opportunities for the rich to grow richer. Thus, their spending patterns do not necessarily change during periods similar to the ones the market is currently experiencing.
This theme was reflected in Farfetch’s most recent Q3 results, with the company posting a gross merchandise value of $967.4 million. In constant currency, GMV grew 4.2% year-over-year. The increase was driven by strong demand for Farfetch’s New Guards (the subsidiary that owns Off-White and Palm Angels, among other labels) brands’ Autumn-Winter 2022 collections.
Further, revenues grew 14.4% in constant currency to $593.4 million. Higher revenues were boosted by a 39.7% increase in in-store revenue as Farfetch pursued the opening of more retail locations, as well as a $13.7 million gain generated by the Reebok partnership that began in March.
Overall, I would argue that Farfetch has no issue when it comes to driving sales, and with growth in sales come economies of scale. In Q3, Farfetch’s gross profit margin expanded 160 bps year-over-year to 44.9%, driven by marketing and warehouse efficiencies. So far, so good, right? Well, despite scaling rather substantially over the past few years, it appears that Farfetch has failed dramatically when it comes to lowering operating expenses. In fact, Farfetch’s spending spree appears uncontrollable.
Absurd Spending Crushes Profitability, Destroys Shareholder Value
Farfetch’s spending spree doesn’t only leave no room for the company to report meaningful profits but has also resulted in heavy dilution that has gradually destroyed shareholder value.
Let’s look at the bright side for a second, as I have to praise Farfetch’s scaling economics. For instance, demand-generation expense declined by 16.7% year-over-year to $61.8 million in Q3, while total investment in technology remained flat compared to last year, at 12.5% of adjusted revenues. But that’s about it. General & administrative expenses jumped 28.8% to $180.5 million, year-over-year, mainly driven by higher salaries. That’s a lot of money. SG&A expenses represented 35.1% of adjusted revenues in Q3 compared to 27.8% last year. The company is basically serving the employees over shareholders by a wide margin at this point.
Also, wait until you hear that this number doesn’t actually include Farfetch’s stock-based compensation. Yes, the company reports stock-based compensation separately, and in Q3, it came in at $84.3 million, up nearly 83% compared to Q3 2021. Just to add some perspective here, at an annualized rate, this figure equals 25.5% of Farfetch’s market cap. The dilution here is just ridiculous, and there seems to be a complete lack of accountability when it comes to maximizing shareholders’ interests.
As a result, Farfetch posted a loss of $274.9 million for the quarter, while cash and equivalents stood at $487.4 million at the end of September. That’s an $875.7 million decline from the $1,363.1 million Farfetch started the year with, which greatly illustrates Farfetch’s cash-bleeding problem.
Is FTCH Stock a Buy, According to Analysts?
Turning to Wall Street, Farfetch has a Moderate Buy consensus rating based on nine Buys, two Holds, and one Sell assigned in the past three months. At $13.22, the average FTCH stock price target implies 202.86% upside potential.
Takeaway: No Path to Sustainable Profitability
Farfetch stock has already declined 85% over the past year, but the stock is likely to remain under pressure as there seems to be no path to sustainable profitability. Expenses are set to continue growing, driven by inflationary pressures, while the company will most probably keep printing stock to stay afloat.
For Q4, management projects even higher costs to support operations, which could further sink the bottom line. For 2022, FTCH targets its adjusted EBITDA margin to be between -3% and -5%, which certainly suggests there won’t be any improvement in profitability anytime soon.
Considering that adjusted EBITDA doesn’t include stock-based compensation and other one-off items, net margins will actually end up being significantly lower as well. Thus, shareholder value deterioration through the short-to-medium term is somewhat guaranteed at this point. Hence, I will most certainly keep avoiding the stock for now.
