svetikd/E+ via Getty Images

svetikd/E+ via Getty Images

Farfetch (NYSE:FTCH ), the London-based digital platform specialising in luxury fashion, saw a huge 20% rise in price in the past week. This is a significant rise, even considering the recent gains in stock markets. It’s even more impressive in the context of its 75% drop in price in 2022 so far. However, with the global macro economy clouded with fears of recession and high inflation eating into consumers’ discretionary spending, this article looks at whether the Farfetch price can continue to rise or if this is just a flash in the pan.

From a thematic perspective, there are two aspects to consider in analysing the company:

1. Luxury goods’ sensitivity to recessions: There are two competing theories. One posits that as discretionary consumer spends, luxury purchases can slow down during recessions. The other theory says that luxury spending is actually recession-proof since it’s driven by the ultra-wealthy, who are insulated from fluctuations in the economy. Since Farfetch focuses on luxury products, is its demand expected to slow down if there’s a recession soon?

2. E-commerce growth: Digital sales grew fast during the pandemic. But was that a short-term phenomenon, or have the prospects for the sector actually bettered for good? Again, this is significant for Farfetch as predominantly a digital platform, though it does have some in-store presence as well.

To assess the fate of the luxury sector, the performance of two companies in the recession led by the financial crisis in 2008 was analysed, which is the closest it gets to the current slowdown. The first is LVMH, the biggest luxury company and Burberry, which like Farfetch is London based. Both saw an impact on performance because of the event. Revenues were down for both. LVMH saw a huge drop in net profits, and Burberry swung into losses. The companies also acknowledge weakening financials because of a poor economy in their result statements from the time. However, it’s interesting to note that by 2010, both show a sharp pickup in earnings, suggesting the sector’s resilience.

Sources: LVMH financial results, Burberry's financial results, Author's Estimates

Sources: LVMH financial results, Burberry's financial results, Author's Estimates

This gives some hope for Farfetch, whose demand has clearly been impacted recently. Its revenue grew by 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 Q1, it’s still slower than the almost 35% rise seen in 2021. It mentions macro events in China and the ceasing of operations in Russia, its second and third-biggest markets respectively, as impacting its performance. Hearteningly, Americas remain strong, which is significant since the US is its top market. On the whole, there is room for optimism as far as its future revenue potential is concerned, especially as projections for the US and recovery in China are strong (see chart below).

It could also be buoyed to some extent by the prospects for apparel e-commerce. According to an IMF study, the spurt in digital sales seen during the pandemic hasn’t persisted on the whole. Digital spending as a proportion of total sales has dropped to 12.2% in 2021 as opposed to 14.9% during the pandemic. It does however say that for apparel, among other sectors, the move to online shopping does appear most long-lasting. BCG also forecasts that 20% of luxury sales by 2025 will be digital as against 12% today. This offers some promise for Farfetch in the medium term, which is essentially a digital platform.

Beyond demand recovery, it’s essential to consider how well Farfetch is coping with inflationary pressures and rising interest rates. As far as price rise is concerned, it’s doing well with a gross margin of 46.2%, which is both a slight improvement over Q1 2022 and the full-year 2021. Its net margins at 12.2% are also fine in the latest quarter, though the company has managed to make net profits only because of re-measurement gains. On an operating basis, it’s still loss-making. Still, there’s some comfort to be found from the fact that its operating expenses' growth has actually slowed down from the same time last year (see chart below).

Farfetch’s market valuations in terms of its price-to-earnings ratio (P/E) make it a cheap stock to buy nevertheless at 2.05x compared to 12.09x for the consumer discretionary segment as a whole. Somewhat related stocks like Etsy (ETSY) and Pinterest (PINS) are valued much higher. Going by the nature of its earnings, though, I'd de-emphasise this indicator for now.

Interestingly, Farfetch has a 1.43x price-to-sales (P/S) ratio, which is actually higher than that for the sector median at 0.23x. If its revenue growth slows down further, this ratio could look even higher. The company’s outlook is fairly muted in its latest results. It points to slowing consumer demand both because of a weak economy and the post-pandemic effect on digital sales as well as disruptions to its supply chains as possible reasons, which give little hope of a revenue recovery soon.

Sources: Financial Times, Seeking Alpha

Sources: Financial Times, Seeking Alpha

In the medium term, there could still be an upside to it, however, going by the broad trends for both luxury goods and e-commerce. Its acquisition of Yoox Net-A-Porter has also been well received, which could add momentum to the company. For the short-term, however, there doesn't seem to be too much upside to the stock. Its outlook is weak, even though it expects some growth in gross merchandise value and is targeting breakeven on adjusted EBITDA. Its P/S is also higher than the industry average. Considering how much it has already fallen though, there’s probably no worse time to sell it, even after a sharp run-up last week. I’d much rather hold it until the tide turns.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.