Rent the Runway (NASDAQ: RENT) is a micro-cap stock whose price target was recently updated by Jefferies. This signals that the name could have nearly triple-bagger upside. According to MT Newswires, analysts at Jefferies updated their price target for the firm on Sept. 6. That target now sits at $26 per share, while the company trades at $9.31 per share. This implies that the analyst believes shares could rise 180% from their current level.

To understand this lofty target, I’ll examine the consumer discretionary firm's operations, competitors, and financial situation.

Rent the Runway Aims to Offer Customers an “Unlimited Closet”

Rent the Runway (RTR) is a fashion company with a unique business model. The company is a platform where customers can rent pieces of clothing. It specifically caters to women, allowing them to rent high-priced designer garments. This allows its customers to access these garments for a much lower price than having to buy them.

This opens up the world of designer clothing to many more people, allowing many users to split the cost of those garments. RTR points out that its average customer wears clothes worth 25 times more than what they pay in subscription fees for the service annually. The company aims to provide its customers with an “unlimited closet,” as they can swap out their garments for other ones whenever they like. It generates revenue mostly through subscriptions to this service, which cost between $94 and $235 per month.

RTR: Improving Profitability Big Time, But a Massive Competitor Is Stealing Growth

Looking at the financials of Rent the Runway, it is a mixed bag. On the positive side, the company is becoming more profitable. The company has increased its gross margin by nearly 600 basis points since fiscal year 2021. Last quarter, its adjusted EBITDA margin was over 17%. That's a 700+ basis point increase from last year.

Additionally, its free cash flow has increased massively. The number through the first six months of 2024 sits at -$6 million, compared to -$30 million in the same 2023 period. The company says it expects to break even on cash flow in 2024.

Looking at cash flow is particularly important for a firm like RTR over net income, as product depreciation expense equals 21% of its revenue. Depreciation is a non-cash expense; it is an accounting expense. So, this isn’t cash that the company is spending. The company deducts it from its net income but not its cash flow.

The ultimate goal of a business is to generate positive cash rather than a positive accounting profit, i.e., net income. A company’s cash flow paints a better picture of its financial situation.

However, a big problem for RTR is the fact that its active subscribers are declining. The figure fell 3% year over year last quarter. Meanwhile, competitors like Nuuly saw active subscribers grow by 55% last quarter. Nuuly's average active subscribers now sit at over 250,000, nearly double that of RTR. This is despite the fact that the company has only been active for around five years versus 15 years for RTR.

This difference signals growth in this industry, but it's not going to RTR. This means that RTR’s offerings are likely viewed as inferior to Nuuly’s and do not give customers the items they want.

Nuuly, owned by the massive firm Urban Outfitters (NASDAQ: URBN), enjoys a big advantage in acquiring a variety of clothing to offer customers. This is very difficult for the small RTR to compete with. This difference in being able to offer a wider variety of options is a likely source of Nuuly’s superior growth. Nuuly also has a lower price point, offering more casual clothing that can appeal to a wider audience.

RTR’s Rock-Bottom Valuation Sparks Wall Street Interest

Despite its issues, it's hard to dismiss RTR’s extremely low valuation. It is trading at nearly one-tenth of its projected sales over the next twelve months. This is assuredly a big reason why some Wall Street analysts place such large price targets on the firm.

Its increasing profitability is great to see, but it likely needs to see growth reaccelerate before the market will give it any credit. If it can’t, this indicates that RTR’s offerings to customers have fundamental issues, and the company can’t expect to succeed long term. Still, its valuation makes it an interesting name to watch if it can find a way to start growing again.