RENT - Rent the Runway Is Making The Right Moves But Debt Remains An Issue

Summary

• RENT has been making moves to improve its margins and cost structure.
• However, its high-interest debt is somewhat onerous.
• As such, RENT is a highly speculative stock.

Rent the Runway ( RENT ) is improving its margins and cost structure to become a better business. However, its high-cost debt and lack of free cash flow make it a highly speculative stock.

Company Profile

RENT is a clothing rental service, which it says gives its customers access to an "Unlimited Closet." The company offers three subscription plans. Its starter plan costs $94 a month after the trial period and allows customers to rent 4 designer items valued at up to $350 each. The next tier up allows customers to rent 8 designer items a month valued up to $3,000 each at a cost of $144 a month.

It most expensive tier costs $235 a month after the trial period and allows subscribers to rent up to 16 items a month valued up to $3,000 each. Each tier allows for 4 items to be rented at one time. The company also allows customers to customize plans if they want.

RENT says it offers over 19,000 styles by over 780 brand partners. Among the items available include evening wear, accessories, "workwear, denim, casual, maternity, outerwear, blouses, knitwear, loungewear, jewelry, handbags, activewear, ski wear, home goods, and kidswear".

If a customer loves an item, they also have the option to purchase it. The company also eventually sells items as well, typically at prices 10-85% off retail.

In addition to subscriptions, RENT also offers one-time rentals for special occasions, like a wedding or holiday party. Customers receive their item 1-2 days before the events and keep them for between 4-8 days in total.

RENT acquires its designer items in several ways. About 40% of its products come via wholesale purchases directly through brand partners. About a third of its items, meanwhile, come via a revenue share with brands ((RTR)) where it gets items on consignment from brands at little to no upfront cost and then shares the revenue with them when the item gets rented out.

RENT also will create its own designs in collaboration with brand partners that it manufactures through third-parties. About 30% of its product acquisitions came from this channel, which it calls Exclusive Designs.

Opportunities

One of RENT's biggest opportunities is its continued shift away from acquiring items via the wholesale channel. Both the RTR and Exclusive Design channels have better economic profiles. Exclusive Designs have about a 50% less acquisition cost than wholesale items, significantly boosting gross margins. RENT is just starting to produce black tie and evening wear Exclusive Designs, 2 of the most expensive categories it costs the company to procure. It has also begun working with more factories to be able to produce more items in more categories. RTR, meanwhile, carries little to no upfront costs, inventory risk, or fashion risk.

The shift away from wholesale has allowed RENT to reduce its upfront cash costs from $118 million in FY2019 to an expected $60 million in FY2022. Its gross margins, meanwhile, have jumped from 21% in FY19 to 39% last quarters (Q3 FY22).

The company is also looking to reduce costs in other areas and announced a restructuring plan in September. It cut its workforce by 24%, which it expects to help save $20 million. It also expects to reduce technology and G&A expenses by another $5-7 million.

On its FYQ2 earnings call announcing the restructuring plan, CEO Jennifer Hyman said:

"So the reductions are just as much about growth as they are about efficiency. So this was the result of rigorous analysis, a rigorous process. We benchmarked against group companies, and we saw the opportunity to become more efficient, which form the size and scope of the cut. But because they're easily about growth, this gives us the ability to reinvest in customer experience and place significant offense.

"We're a proactive organization, and we follow the data. This is what we did when we saw the very early impacts of COVID, and we acted early and meaningfully. And as promising as the bounce back has been in August and September, we simply can't predict what's going to happen in the next 12 months. These changes put us in a strong position to continue to grow both in the immediate and once the environment is fully recovered.

"On the financial front, we think this is transformative for the business. We go from a business that's been burning a lot of cash to one that has much tighter cost structure in the short term can fund product costs for its existing customer base and reduce burn to approximately $30 million before interest at approximately $400 million in revenue."

Increasing users and driving revenue, obviously, is another important opportunity. The company doesn't spend much on advertising, instead relying on word of mouth and customer experience. However, it did recently launch its first celebrity collection with Ashley Park, who plays Mindy Chen on Netflix's ( NFLX ) popular Emily in Paris show.

On the technology end, the company is working to improve its tech stack and search capabilities. It's looking to greatly improve the speed of its website, as well as better marry its customer data to individual experiences.

RENT could also benefit from the trend of workers returning back to the office. While the company has seen a nice shift towards casual wear, work clothes were a large part of its business pre-pandemic. And as more companies push workers back into the office, many could look to refresh their wardrobes.

Risks

RENT has yet to prove that it can be free cash flow positive. The company has said that at $400 million in revenue it would have around $30 million in cash outflows before interest expenses, which takes into account the cost savings from its restructuring program. Note, however, that the company isn't projected to generate $400 million in revenue until FY25 (ending in January).

The company also has nearly $275 million in debt ($100 million net), on which it is paying 12% interest, with up to 5% payable in kind. That's another essentially $30+ million in cash outflows. Yes, some of it may be PIK, but it's still being accrued and will need to be repaid.

For a company with a $250 million market cap, this is a pretty big liability.

Valuation

Based on the FY2024 EBITDA consensus of $37 million, RENT trades at an EV/EBITDA multiple of about 10x. Based on the FY2025 EBITDA estimate of $64 million, it trades at 6x.

The company is projected to grow revenue between 18-20% in both FY24 and FY25, after 45% projected growth in FY23.

Stitch Fix ( SFIX ) may be the closest comparable, but it is not expected to be EBITDA positive anytime soon and has a better balance sheet.

Conclusion

RENT appears to be doing a number of right things to improve its business by improving margins and right-sizing its cost structure. Meanwhile, the company has also done a good job of nicely growing revenue the past two years, putting up 29% growth in FY22 and expected growth of around 45% when it reports its FY23 results in a couple months.

That said, the company is burning cash and its high-cost debt is onerous. The debt burden is an issue that RENT should have tried to wipe away when it IPO'd in the fall of 2021. The stock is down -80% from its IPO, when it priced its shares at $21, the high end of its range.

Given this, RENT is a highly speculative stock at this point. I think management is doing enough to make a speculative bet on the name, but only with the knowledge that if growth slows and/or costs tick up, things could get even uglier for the stock.

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