Farfetch (NYSE: FTCH), the London-based digital platform specializing in luxury fashion, saw its prices rise by 20% last week. This is a significant increase, even given recent stock market gains. It is even more impressive in the backdrop of its 75% price drop in 2022 so far. However, with the global macro economy clouded by recession fears and high inflation eating away at consumer discretionary spending, this article examines whether the Farfetch price can continue to rise or if it is just a flash in the pan. .
Major themes: Luxury in recessions and e-commerce
From a thematic point of view, there are two aspects to consider in the analysis of the company:
1. Sensitivity of luxury to recessions: Two opposing theories. One posits that as discretionary consumer spending, luxury purchases may slow during recessions. The other theory says that luxury spending is actually recession proof since it is driven by the ultra-rich, who are insulated from the ups and downs of the economy. Given that Farfetch is focused on luxury goods, should its demand slow in the event of an upcoming recession?
2. Growth of e-commerce: Digital sales have grown rapidly during the pandemic. But was this a short-term phenomenon, or has the outlook for the sector really improved for good? Again, this is important for Farfetch as a primarily digital platform, although it also has some in-store presence.
Luxury goods are not withstanding the recession
To assess the fate of the luxury sector, the performance of two companies in the recession caused by the 2008 financial crisis was analyzed, which comes closest to the current downturn. The first is LVMH, the biggest luxury company, and Burberry, which, like Farfetch, is based in London. Both saw a performance hit due to the event. Revenues were down for both. LVMH saw a huge drop in net profit and Burberry suffered losses. Companies also acknowledge weakening finances due to a poor economy in their earnings statements of the time. However, it is interesting to note that in 2010, both are showing a strong recovery in profits, which suggests the resilience of the sector.
Farfetch’s demand outlook
This gives some hope to Farfetch, whose demand has clearly been impacted lately. Its revenue increased 10.7% year-on-year (YoY) in the April-June 2022 quarter (Q2 2022). While this is an improvement from the 6.1% rise seen in the first quarter, it is still slower than the nearly 35% rise seen in 2021. She mentions macro events in China and the cessation of operations in Russia, its second and third markets respectively, as impacting its performance. It is encouraging to see that the Americas remains strong, which is important since the United States is its first market. Overall, there is room for optimism regarding its future earnings potential, especially as projections for the US and recovery in China are solid (see chart below).
The outlook for e-commerce is shrinking
It could also be supported to some extent by the apparel e-commerce outlook. According to an IMF study, the surge in digital sales seen during the pandemic has not persisted overall. Digital spending as a proportion of total sales fell to 12.2% in 2021 from 14.9% during the pandemic. He says, however, that for apparel, among other sectors, the shift to online shopping seems the most sustainable. BCG also predicts that 20% of luxury sales by 2025 will be digital compared to 12% today. This offers promise for Farfetch in the medium term, which is essentially a digital platform.
Manage inflation and rising interest rates
Beyond the recovery in demand, it is essential to examine how far Farfetch is coping with inflationary pressures and rising interest rates. On the upside, it is doing well with a gross margin of 46.2%, which is both a slight improvement over the first quarter of 2022 and the full year of 2021. Net margins at 12.2% are also strong last quarter, even though the company managed to turn a net profit solely on revaluation gains. On an operational basis, it is still in deficit. Still, there is some comfort to be found in the fact that its operating expense growth has actually slowed compared to the same period last year (see chart below).
The issue of valuation
Farfetch’s market valuations in terms of price-to-earnings (P/E) ratio nevertheless make it a cheap stock to buy at 2.05x versus 12.09x for the broader consumer discretionary segment. Somewhat related stocks like Etsy (ETSY) and Pinterest (PINS) have a much higher value. Due to the nature of its earnings, however, I would place less emphasis on this metric for now.
Interestingly, Farfetch has a price-to-sales (P/S) ratio of 1.43x, which is actually higher than the industry median at 0.23x. If its revenue growth slows further, this ratio could look even higher. The company’s outlook is quite mixed in its latest results. It points to slowing consumer demand both due to a weak economy and the post-pandemic effect on digital sales as well as disruptions to its supply chains as possible reasons, leaving little hope of an early recovery in income.
Wait for the turnaround
In the medium term, however, there could still be an advantage, if we rely on the major trends in luxury and e-commerce. Its acquisition of Yoox Net-A-Porter has also been well received, which could give the company further momentum. In the short term, however, there doesn’t seem to be too much upside for the title. Its outlook is weak, although it expects some growth in gross merchandise value and aims to break even on adjusted EBITDA. Its P/S is also above the industry average. Considering how much it’s already fallen, there’s probably no worse time to sell it, even after a strong rally last week. I much prefer to hold it until the tide turns.