Is It Too Late to Buy Rent the Runway Stock?

Rent the Runway's (RENT -8.02%) stock skyrocketed 74% on Dec. 8 after the high-end apparel rental marketplace posted its latest quarterly report. For the third quarter of fiscal 2022, which ended on Oct. 31, its revenue rose 31% year over year to $77.4 million and beat analysts' estimates by $4.1 million. Its net loss narrowed from $87.8 million to $36.1 million, or $0.56 per share, which met the consensus forecast.

Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) came in at positive $6.6 million, compared to an adjusted EBTIDA loss of $5.6 million a year ago and the consensus forecast of positive $1.3 million. As a result, its adjusted EBITDA margin expanded from negative 9.5% to positive 8.5%.

Image source: Getty Images.

Rent the Runway expects its revenue to rise 12%-15% year over year in the fourth quarter, and to increase 44%-45% for the full year. Both of those estimates easily exceeded Wall Street's expectations. It also expects to post a positive adjusted EBITDA margin of 1% for the full year, compared to its negative adjusted EBITDA margin of 9.4% in fiscal 2021. Those headline numbers were impressive, but is it too late to buy Rent the Runway's stock after its post-earnings pop?

Slower but steadier growth

Rent the Runway lets customers either rent high-end designer apparel through one-time rentals, which can cost around $30 to $150 on an a la carte basis, or purchase one of three tiers of monthly subscriptions, which cost between $94 to $235 and provide four to 16 clothing rentals each month. It also lets its customers directly buy those products from its marketplace.

The company generates most of its revenue from its subscriptions. Its number of active subscribers rose 110% to 115,240 at the end of fiscal 2021 (which ended in January 2022), but decelerated throughout the first three quarters of fiscal 2022. As a result, its revenue growth also cooled off.

Data source: Rent the Runway. YOY = Year-over-year.

The company mainly blames that slowdown on inflation, which curbed the average consumer's appetite for high-end apparel rentals. However, it partly offset its slower growth in active subscribers by consistently boosting average revenue per user (ARPU) with add-on slots, which let its subscribers increase their monthly allotment of rentals, as well as "moderate" price hikes. That's why the company still expects its ARPU to rise about 7% for the full year.

Tighter spending and narrower losses

Rent the Runway's net loss widened from $171 million in fiscal 2020 to $212 million in fiscal 2021. Soaring fuel and logistics costs also generated fierce headwinds for the company this year, since it provides free shipping to all of its paid subscribers. As a result, the company posted a net loss of $113 million in the first nine months of 2022.

But by September, it recognized those challenges and announced it would lay off about 24% of its employees by the end of the fiscal year. Those layoffs, along with its lower marketing, technology, and general and administrative expenses, finally lifted its adjusted EBITDA to positive territory over the past two quarters. CEO Jennifer Hyman believes its adjusted EBITDA margin could eventually rise to about 15% in the "medium term".

Rent the Runway still looks cheap

Rent the Runway didn't provide any guidance beyond the fourth quarter, but analysts expect its revenue to rise about 16% in fiscal 2023. However, those estimates will likely be revised upwards after its latest earnings beat.

Based on those expectations and its enterprise value of $209 million, Rent the Runway's stock still looks cheap at 0.6 times next year's sales. It's admittedly pricier than Stitch Fix (SFIX -0.94%), which trades at 0.2 times next year's sales, but Stitch Fix faces much tougher near-term headwinds and remains unprofitable on an adjusted EBITDA basis.

However, Rent the Runway's limited liquidity ($186 million in cash, cash equivalents, and restricted cash at the end of the third quarter) and $275 million in long-term debt still make it a wobbly investment. Its adjusted EBITDA might be improving, but its cash flows won't turn positive until it turns profitable on a GAAP (generally accepted accounting principles) basis.

I believe Rent the Runway's stock is worth nibbling on at these levels, since it dominates a niche market, it's fundamentally cheap, and its stock is still trading nearly 90% below its IPO price from last October. However, it probably won't rally further over the next few quarters as rising interest rates cast a long shadow over out-of-favor growth stocks.