Better to Buy: Stitch Fix vs. Rent the Runway

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stitch correction (SFIX 3.60%) and Rent the track (LEASE -1.28%) both attempted to disrupt the retail apparel industry in unique ways. Stitch Fix picked out outfits for their customers, delivered them in five-item “fixes,” and only charged them for the products they kept. Rent the Runway allows its customers to rent high-end designer clothing through subscriptions. It also allowed them to purchase these products directly.

However, both stocks are currently trading at significant discounts to their IPO prices. Let’s take a look at why these two innovative companies have faded — and whether either stock is still worth buying as a deep value play.

Image source: Getty Images.

What happened to Stitch Fix?

Stitch Fix has seen its number of active customers fluctuate quite a bit – from 2.74 million at the end of fiscal 2018 (ending in July) to 4.17 million at the end of 2021 and 3.8 million at the end of 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 a slowdown in discretionary spending in clothing”.

This slowdown was exacerbated by the introduction of Freestyle by Stitch Fix, a new feature that allows shoppers to directly purchase single products instead of receiving full fixes over the past year. Last December, Spaulding warned that Freestyle could cannibalize its patches as it tries to expand its customer base. Its Freestyle business grew at a faster rate than its Fixed-line business last quarter, but its active customers and revenue were still down year-over-year, indicating that its core business continues to contract.

As a result, Stitch Fix’s revenue fell 1% to $2.07 billion in fiscal 2021 – its first annual drop in revenue since its IPO – and it expects another decline of 10% to 15% in fiscal 2022. As its revenue growth slowed, its margins contracted as it marked down more merchandise and rising gasoline prices inflated its logistical expenses.

This is why Stitch Fix has become unprofitable over the past three years. Its net loss fell from $9 million in fiscal 2021 to $207 million in fiscal 2022, and analysts expect it to post another net loss of $184 million. dollars this year, even though it recently laid off about 15% of its workforce.

Stitch Fix thinks it can win more customers with new marketing campaigns and the expansion of Freestyle, but it’s still unclear whether this flawed business model is actually sustainable. It’s the kind of business that needs to grow significantly to generate stable profits – but its maximum customer growth and shrinking margins could prevent that from happening.

What happened to Rent the Runway?

Rent the Runway is growing much faster than Stitch Fix. Its total number of active subscribers increased by 110% to 115,240 at the end of fiscal 2021 (which ended in January 2022), and further increased by 27% year over year. to reach 124,131 by the end of the second quarter of fiscal 2022. But from mid-June onwards, an increasing number of subscribers suspended or canceled their subscriptions as inflation dampened the market’s appetite for rental and the purchase of high-end clothing.

Despite this short-term downturn, CEO Jennifer Hyman said on the company’s latest conference call that its “cloud wardrobe model for fashion” was still in “first run” 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 macro headwinds fade in the second semester.

This high profile orientation is promising, but Rent the Runway has never generated a profit by renting out its expensive clothes. Its net loss fell from $171 million in fiscal 2020 to $212 million in fiscal 2021, and analysts expect 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 expects to be able to stabilize its Adjusted EBITDA margin (earnings before interest, taxes, depreciation and amortization) at around 15% in the medium term, but this is an ambitious objective given that its Adjusted EBITDA has just turned positive for the first time since its IPO last quarter. But it’s still faring much better than Stitch Fix, which is expected to remain unprofitable based on adjusted EBITDA until at least fiscal 2025.

Rent the Runway’s business model looks healthier than Stitch Fix’s, but it also needs to grow its business significantly to generate stable profits. That could be tough, especially if a recession dampens consumer spending, smaller competitors expand similar platforms, and high-end apparel companies start leasing their own products.

The winner: Rent the track

Both of these stocks look very cheap at less than one times their annual sales. But they are trading at such deep discounts because they are not profitable at all and they still need to expand their business. 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.

Leo Sun has no position in the stocks mentioned. The Motley Fool has positions and recommends Stitch Fix. The Motley Fool has a disclosure policy.

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