FIGS (NYSE:FIGS) 2Q24 results were not spectacular, with the company posting moderate growth and improved guidance, but at the expense of lower margins. The company is spending more on product and marketing to drive the top line.

My view on the company and the stock has not changed. FIGS has a good product, but its lack of cost management financed by a high gross margin makes it vulnerable to competition from below. The stock discounts a significant improvement in operating margins, and sales growth, making it not opportunistic. I maintain my Hold rating.

2Q24 results

Top-line improvements: FIGS had a rough start for the year, with revenues down 1%, and guiding for FY24 revenues between flat and down 5%. However, the company seems to have turned that trend a little, with 2Q24 revenues up 4.4%, and guidance updated to flat to up 2%.

Margin impact: The problem is that the topline growth has been driven by initiatives that are damaging the company’s margins, at least in the short term. The company’s adjusted EBITDA margins fell to 400bps, and the operating margin was a meager 1%, from 4.7% in the same quarter last year.

On the gross margin side, the 200 bps impact comes from launching new SKUs, which impacts supply chain efficiencies. Non-scrubs products grew 13% and now represent 18% of sales. Management is confident the margins on these products will improve.

The second impact comes from selling and marketing. Selling delivered 120 bps from a distribution center transition, and marketing delivered 90 bps from higher top-of-the-funnel expenses (like sponsoring and outfitting the medical Olympic Team USA). This was offset by 40bps of improvement in G&A from lower SBC. Marketing in particular can probably be directed to demand creation and growth.

Guidance for the year in line with Q2: The company expects to have flat sales, with gross margins down to 200bps, and adjusted EBITDA margins down to 10%, versus 16% in FY23. The company is growing at the expense of its already thin margins. The adjusted EBITDA figure includes 7 percentage points of SBC.

The margin problem thesis: My main concern with the company not protecting its margins is that it makes it vulnerable to competition from lower overhead competitors. FIGS’ products are of higher quality, but the 70% gross margins imply there is a lot of space for a competitor to come up with a similar-quality product at a lower price. With razor-thin operating margins, FIGS is not in a position to fight back with lower pricing.

Valuation remains unattractive

Even though other readers may agree with FIGS’ management strategy of sacrificing margins for growth, and investing in new products, and top-of-funnel marketing, I still believe the stock is overpriced.

Today, FIGS trades at a market cap of $1.06 billion, or about $800 million ex-net cash. Against this, the company can probably generate $11 million in operating profits this year, or less than $8 million in net income (being generous about their operating margins and tax rate). That is a PE of 100x, or a yield of 1%.

If the company managed to quadruple its operating margins to 8%, it would still trade at a P/E of 33x. If, after that, it doubled its size to revenues of $1 billion, it would still trade at a P/E of 16x.

I guess the idea is clear. I do not think FIGS is a fantastically run company, but even if I did, the stock price cancels most of the upside because even while doubling its size and quadrupling margins, it would still trade at a valuation that can be considered high for an apparel brand. If those optimistic assumptions do not materialize, the stock is even more expensive.

For that reason, I continue to believe FIGS is not an opportunity at these prices, and maintain a Hold rating.