Farfetch Ltd. (FTCH, Financial), a prominent player in the luxury e-commerce sector, has faced a tough year, with its market value declining more than 60% in 2023. The company's losses have been growing, and Farfetch is struggling to find its footing.
One of the major challenges for Farfetch has been the disruption in Russia and a slowdown in China, its third-biggest market. These setbacks have made it difficult for the company to turn a profit. In response to these difficulties, Farfetch, like many other tech companies, has adjusted its 2023 financial outlook to better align with the unpredictable global economic conditions.
On a more positive note, the European Commission recently gave the green light for Farfetch to acquire Richemont's YNAP. This strategic move might just be the boost the company needs to navigate through the challenges it is facing in the luxury retail industry. A closer look at the long-term prospects for the company, the competitive landscape in the luxury e-commerce sector and its current valuation suggest the risk-reward profile of investing in Farfetch is in favor of long-term-oriented investors today.
Farfetch is struggling to recover
Farfetch runs an online marketplace where shoppers can connect with over 1,400 brands and boutiques from all around the world. The company saw impressive growth in 2020 and 2021, generating substantial revenue, even though luxury prices were on the rise. The pandemic played a role here, too, as it actually boosted the disposable income of many high-paying customers.
One interesting aspect of the luxury market are so-called romantic buyers. These are the people who are not just looking for something physical, but buy luxury items to satisfy their emotional needs and desires. Also, during the pandemic, people turned to retail therapy, splurging on non-essential items as a way to cope with stress. Buying something special can give a sense of control in an uncertain world. These trends all played a part in Farfetch's success and highlighted how the luxury industry has adapted to these changing times. According to a McKinsey Report, the fashion industry experienced a remarkable 21% growth in revenue from 2020 to 2021, accompanied by a significant doubling of Ebitda margins by 6% to 12.3%. Farfetch's revenue increased from $1.02 billion in 2019 to $2.25 billion in 2021, representing a compounded annual growth rate of 48%.
Central to this growth story was the surging demand for luxury goods, particularly in the Chinese market. Farfetch adeptly capitalized on this appetite for high-end products and, in doing so, the company found a significant revenue driver. Further, Farfetch's innovative approach, characterized by the diversification of its product offerings and services, played a pivotal role in expanding its customer base and enhancing its financial performance.
Notably, after more than a decade since its inception and over two years following its initial public offering, Farfetch achieved Ebitda profitability for the first time, aided by the pandemic boost. This milestone was the result of a digital-first strategy, a relentless focus on innovation, substantial investments in the New Guards Group and a strengthened presence in China, fostered by the strategic partnership between Alibaba Group Holding (BABA, Financial) and Richemont (XSWX:CFR, Financial).
The transformation extended beyond revenue figures, as Farfetch demonstrated impressive improvements in net income. In 2019, the company reported a loss of $405 million, but in 2021, the company reported a profit of $1.47 billion. Certain non-recurring items helped the company's journey, but in general, this financial turnaround can be attributed to Farfetch's multifaceted strategic initiatives. These include the expansion of brand partnerships, the enhancement of the consumer experience and the scaling of platform solutions.
The pandemic catalyzed the digitalization of the luxury industry, and Farfetch was well-positioned to reap the benefits of this trend. As more consumers turned to online shopping for their luxury needs, the company's digital strength and diversified offerings ensured its position at the forefront of this transformation.
In contrast to its previous growth trajectory, Farfetch faced a complex set of challenges in 2022. A combination of factors converged to create a testing environment for the company.
The impact of higher interest rates sent ripples across the tech sector, affecting Farfetch's operations. Geopolitical tensions arising from the conflict between Russia and Ukraine further exacerbated these challenges. Additionally, the slow recovery of demand in mainland China, primarily due to prolonged mobility restrictions, added to the company's challenges in 2022. Consequently, Farfetch's revenue for the year came in at $2.31 billion, marking a modest year-over-year growth of only 2.66%. The company reported net income of just $359 million last year, with Farfetch's aggressive growth investments proving to be a toll on operating margins.
While revenue exhibited some signs of improvement in the first quarter, growing 8%, the company reported a net loss of $174 million. The second quarter of 2023 witnessed a revenue decline of 1%, accompanied by a substantial net loss of $281 million.
A silver lining amid these difficulties is the rebound in Farfetch's e-commerce sales in the first half of 2023. The digital platform revenue increased by 6.5% to $421.5 million in the first quarter, driven by digital platform services first-party revenue, which increased 28.2% year over year. This surge can be partly attributed to the receding inflation in the United States and China's decision to phase out its zero-Covid policy. In the second quarter, digital platform gross merchandise value was up 7% and services revenue was up 10%.
Source: Earnings presentation
Despite this growth, the company encountered setbacks in its brand platform revenue in the second quarter. The decline was significant, with a sequential drop of 41% and a year-over-year decrease of 42%. These challenges were largely a result of macroeconomic headwinds, which had a ripple effect on many third-party retailers, prompting them to scale back their intake of new inventory.
The delay in shipping wholesale orders added to Farfetch's woes during this period. It is estimated that around $50 million in revenue, with a roughly 50% gross margin, was pushed from the second quarter to the latter part of the year due to these shipping delays. The impact was particularly pronounced in the brand platform's GMV, which plummeted by 41%. This decline was attributed to the delayed shipment of wholesale goods as retailers adjusted their deliveries for the fall and winter seasons while working through their existing spring and summer inventory.
Source: Earnings presentation
In summary, Farfetch is at a crossroads where it is trying to focus on profitability without hindering its growth potential. The company is highly unlikely to enjoy the accelerated growth rates seen in 2020 and 2021, but at the same time, its growth is unlikely to remain stagnated for a long time as the company is operating in a fast-growing market segment and is benefiting from scale.
New partnerships to drive growth
In 2022, Farfetch announced plans to purchase a stake in online fashion retailer Yoox Net-a-Porter (YNAP) to become the leading e-commerce platform for luxury fashion. Farfetch was waiting for the European Commission's approval to close the deal. In a recent press release, the company announced the commission's approval of the acquisition of a 47.5% stake in YNAP, along with a 3.2% stake by Alabbar. This marks a significant development for the company. Under this arrangement, Richemont, a prominent player in the luxury sector, will receive Farfetch Class A ordinary shares in exchange for its stake in YNAP. This collaboration effectively positions Farfetch as the dominant player in the online luxury space.
One of the central pillars of this deal is the utilization of Farfetch Platform Solutions, a service that empowers luxury brands to seamlessly integrate online and offline experiences for their customers. This not only enhances the customer journey, but also streamlines operations for both YNAP and Richemont's brands.
The agreement between the two companies is set to unfold over the next five years, subject to certain conditions. During this period, Farfetch will progressively acquire the entirety of YNAP, while Richemont, in turn, is poised to become a significant shareholder in Farfetch with an expected 12% to 13% ownership of its issued share capital. This consolidation of forces positions Farfetch as a formidable competitor in the online luxury segment, positioning it against other major players like 24S and Mytheresa.
The long-term outlook
Farfetch's revised forward guidance paints a mixed picture of the company's short-term financial landscape. The adjustment in its 2023 expectations revealed challenges as well as a strategic commitment to addressing them.
In the revised guidance, Farfetch expects a notable reduction in revenue and GMV compared to earlier projections. Group GMV, which is a critical indicator of the company's business, is now expected to be $4.4 billion, down from the previous projection of $4.9 billion. This downward revision extends to both the Digital Platform GMV, which is now set at $3.85 billion (previously $4.2 billion), and the Brand Platform GMV, reduced to $0.45 billion (from $0.6 billion). Farfetch also lowered its adjusted Ebitda margin outlook for 2023, aiming for around 1%, which is near the lower end of the previously guided range of 1% to 3%.
The management's perspective on the digitalization of the luxury industry is noteworthy. They see the digitalization journey in the luxury market as being in its early stages, with digital sales accounting for just over 20% of the mix, but anticipated to expand to over 30% by 2030. Based on this, the company aims to achieve a $10 billion GMV, generate approximately $400 million in adjusted Ebitda and strong free cash flow by 2025.
To curb mounting losses, Farfetch has already taken significant cost-saving initiatives, with approximately $150 million of planned 2023 fixed costs eliminated in recent months. This includes streamlining various teams and rationalizing expenses, effectively rolling back to 2020 spending levels in certain areas. These structural reductions are expected to yield greater savings in 2024, aligning with the company's pursuit of its 2025 profitability targets.
While Farfetch is making strides to improve its financial performance, the path is not without its challenges. The company still incurred a substantial net loss as highlighted before in the first half of 2023, although management anticipates a positive adjusted Ebitda margin of 1% for the year, a notable improvement from -5% in 2022. Further, liquidity remains a concern, with a significant drop in cash and cash equivalents on the cards, but the recent expansion of its loan facility aims to bolster its cash position by year-end.
If Farfetch survives the short-term challenges - which is the most likely scenario going by how operating cash flows swung to positive territory in the second quarter while the company ended the quarter with $453 million in cash - the company will be in a strong position to make the most of the expected digitalization of the luxury market. According to Morningstar analyst Jelena Sokolova, the online penetration of the luxury goods market will increase to 35% by 2030, with Farfetch's market share expected to increase to 10% from just 5% today. In this phase of the business, Farfetch is primarily focused on establishing competitive advantages that would help the company grow profitably in the long run. The recent strategic decisions suggest that Farfetch is making the right moves to achieve this objective.
Takeaway
Farfetch has yet to turn consistent profits and therefore, using price-earnings multiples to estimate the intrinsic value of the company is unlikely to yield meaningful results. Based on the price-sales ratio, Farfetch is attractively valued with the company trading at a multiple of 0.3 compared to the five-year average of 6. This massive difference between historical and current valuation multiples seems to be stemming from the negative investor sentiment toward the company's short-term prospects, but for long-term-oriented investors, this creates a good opportunity.
