RENT - Rent the Runway Q4 Earnings: A Lot Of Moving Parts

2023-04-13 03:31:18 ET

Summary

• Rent the Runway might be down significantly from its IPO, but it's not out.
• Here I highlight some bullish and bearish considerations for both sides to consider.
• Arguably, the key takeaway from this quarter is that Rent the Runway's FCF breakeven is now likely to arrive within 2 years.

Investment Thesis

Rent the Runway ( RENT ) is a very contentious stock. There's enough in these results for both the bears and the bulls. The bears will continue to question whether there's truly a sustainable business model here or whether the company is doomed to continue burning through its free cash flow.

While on the other hand, the bulls will point to the fact that all enthusiasm has now dropped from the stock, but that Rent the Runway's active subscribers figures are still climbing, even now.

For my part, I remain neutral on RENT stock, as I see the validity of both arguments.

Why Rent the Runway? Why Now?

Rent the Runway rents out high-end clothing and accessories. The company's narrative is compelling, and of that, there's no doubt. Meanwhile, its shareholders have been through a seriously tumultuous time. The company came out of the IPO gates and saw its share price drop, only to recoup much of its lost ground in the last several months.

The problem here is to discern how much of its failure to impress is due to the macro environment versus a business model that's simply not viable.

And then, to further confounding matters, we can't take away from the company the fact that even at this stage, Rent the Runway's active subscriber base ended fiscal Q4 2022 up 10% y/y at 126.7K.

And looking ahead to the latest figures, consider the graphic that follows.

Even if we make the case that Rent the Runway's business model isn't viable today, these sorts of active subscriber numbers should make anyone openly bearish the stock pause for thought.

Revenue Growth Rates Fizzle Out

Further complicating matters is that Rent the Runway's growth rates for the year ahead leave a lot to be desired. Even if we acquiesce that Rent the Runway has in the past guided extremely conservatively only to later beat estimates by a fair margin.

Nevertheless, the fact of the matter is that fiscal 2023 is very much unlikely to grow by more than mid-10s% CAGR. That's a massive drop from the 46% y/y that Rent the Runway reported for the prior year.

That's on consideration in the background, but now, let's get to the heart of the investment case, by posing this contentious question.

Can Rent the Runway Reach Breakeven Free Cash Flow Soon?

Before attempting to answer this, let's first turn our focus to what Rent the Runway's founder and CEO Jennifer Hyman said on the call ,

[...] in early March of this year [we changed] all our subscription programs to offer more items for the same price with minimal impact to our gross margins anticipated versus fiscal year '22. And the customer response has been incredible.

Rent the Runway is attempting to deliver more value to customers for the same price. Or put another way, Rent the Runway is discounting its value proposition.

Even if the company contends that this won't impair its gross profitability, clearly this is contrary to the company's aspirations of selling to its high-end demographic?

This immediately tells me that the company doesn't have much pricing power. Rather than being able to upscale its offering to premium tiers, the company is downscaling to offer more merchandise for the same value .

Moving on, Rent the Runway finished fiscal 2023 with a negative free cash flow of $120 million. That's a clean figure for free cash flow. However, Rent-the-Runway's management went on to say during the call,

With 185,000 average subscribers, we anticipate that we would be free cash flow breakeven on a maintenance basis, meaning that we fully cover our variable costs, our fixed costs, as well as the product replenishment spend required for these subscribers.

Given that Rent the Runway already has close to 140K active subscribers, or at least it's likely to finish fiscal Q1 with this number of active subscribers, this implies that within 2 years or sooner, Rent the Runway could reach free cash flow breakeven.

That being said, the bull case is then further complicated by the fact that Rent the Runway holds about $120 million of net debt. And that the debt carries interest payments of nearly $9 million per quarter.

The Bottom Line

There are so many moving parts here that it's difficult to get either extremely bullish or particularly bearish. It's nearly as if one wants to root for the underdog and believes that Rent the Runway can survive and thrive.

But then you consider how much debt the business has, the interest payments on that debt of nearly $10 million every 90 days, and the fact that its free cash flow breakeven is still a long while away, and all that makes one think, is this just a ''return-free risk''?

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