Stitch Fix (SFIX -4.64%) and Rent the Runway (RENT -6.17%) both tried to disrupt the retail apparel industry in unique ways. Stitch Fix picked out outfits for its customers, delivered them in "Fixes" of five items, and only charged them for the products they kept. Rent the Runway let its customers rent high-end designer clothes through subscriptions. It also let them directly purchase those products.

However, both stocks currently trade at steep discounts to their IPO prices. Let's see why these two innovative companies lost their luster -- and if either stock is still worth buying as a deep value play. 

Two workers getting ready to ship an order of clothes.

Image source: Getty Images.

What happened to Stitch Fix?

Stitch Fix has seen its number of active clients fluctuate quite a bit -- from 2.74 million at the end of fiscal 2018 (ended July) to 4.17 million at the end of 2021 and back down to 3.8 million by the end of 2022. During the fourth-quarter conference call, CEO Elizabeth Spaulding blamed the slowdown on "record inflation levels and a deteriorating retail landscape" which "resulted in slower discretionary spend in apparel."

That slowdown was exacerbated by Stitch Fix's introduction of Freestyle, a new feature that enables shoppers to directly buy single products instead of receiving full Fixes over the past year. Last December, Spaulding warned that Freestyle could cannibalize its Fixes as it tried to broaden its customer base. Its Freestyle business grew at a faster pace than its Fixes business last quarter, but its active clients and revenue still declined year over year -- which indicates its core business is still shrinking.

As a result, Stitch Fix's revenue dipped 1% to $2.07 billion in fiscal 2021 -- representing its first annual revenue decline since its IPO -- and it expects another 10%-15% drop in fiscal 2022. As its revenue growth decelerated, its margins contracted as it marked down more merchandise and rising gas prices boosted its logistics expenses. 

That's why Stitch Fix turned unprofitable over the past three years. Its net loss ballooned from $9 million in fiscal 2021 to a whopping $207 million in fiscal 2022, and analysts expect it to post another net loss of $184 million this year -- even though it recently laid off about 15% of its workforce.

Stitch Fix believes it can gain more clients with fresh marketing campaigns and the expansion of Freestyle, but it's still unclear if this wobbly business model is actually sustainable. This is the kind of company that needs to scale up significantly to generate stable profits -- but its peaking growth in clients and shrinking margins could prevent that from ever happening.

What happened to Rent the Runway?

Rent the Runway is growing a lot faster than Stitch Fix. Its total number of active subscribers rose 110% to 115,240 at the end of fiscal 2021 (which ended in January 2022), and rose another 27% year over year to 124,131 at the end of the second quarter of fiscal 2022. But starting in mid-June, a growing number of subscribers either paused or canceled their subscriptions as inflation curbed the market's appetite for high-end apparel rentals and purchases.

Despite that near-term slowdown, CEO Jennifer Hyman said on the company's latest conference call that its "closet in the cloud model for fashion" was still in an "early inning" with plenty of room for growth. Revenue rose 29% to $203 million in fiscal 2021, and the company still expects 40% to 43% growth this year as some of the macroeconomic headwinds wane in the second half of the year.

That top-line guidance is promising, but Rent the Runway hasn't ever generated a profit from renting out its pricey apparel. Its net loss widened from $171 million in fiscal 2020 to $212 million in fiscal 2021, and analysts anticipate another loss of $145 million in fiscal 2022 -- even though it plans to lay off about 24% of its employees by the end of the year.

Rent the Runway believes it can stabilize its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin at about 15% in the medium term, but that's a lofty goal considering that its adjusted EBITDA just turned positive for the first time since its IPO last quarter. But it's still faring a lot better than Stitch Fix, which is expected to remain unprofitable on an adjusted EBITDA basis through at least fiscal 2025.

Rent the Runway's business model looks healthier than Stitch Fix's, but it also needs to significantly scale up its business to generate stable profits. That could be challenging, especially if a recession curbs consumer spending, its smaller competitors expand their similar platforms, and higher-end clothing companies start to rent out their own products.

The winner: Rent the Runway

Both of these stocks look dirt cheap at less than one times their annual sales. But they're trading at such steep discounts because they're deeply unprofitable and still need to scale up their businesses. I wouldn't rush to buy either stock as long as rising interest rates continue to crush unprofitable companies.

But if I had to choose one over the other, Rent the Runway's superior growth, simpler business model, and clearer goals for the future make it the more compelling investment.