🏡 RH: Nothing Stopping this Bullet Train
Why Restoration Hardware (RH) has, is, and will continue to kill it in the home furnishings and experiential department.
RH has seen an over 700% return since the start of the pandemic and with its most recent pullback, the stock looks attractive at these levels
The company’s push into international galleries provides the company with long-term growth and an untapped luxury furnishings market of ~$40bn
Management’s strong execution of growth strategy have set it up for continued success in North America
Strong, triple-digit growth in earnings from FY2020 allows RH to command a higher P/E multiple and thus, higher implied valuation
RH RH 0.00, formally known as Restoration Hardware, is a US-based specialty retailer in the home furnishings category. RH sells products in various categories, including furniture, lighting, textiles, bath-ware, decor, outdoor and garden, and child and teen furnishings.
The company operates a portfolio of retail galleries, Source Books (a series of catalogs), and an e-commerce business.
As of May 1, 2021, we operated a total of 68 RH Galleries and 38 RH outlet stores in 30 states, the District of Columbia, and Canada, as well as 14 Waterworks Showrooms throughout the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.
RH is different than many home furnishings companies in that it is incredibly simplistic in how it runs its business model. It does not sell any seasonal products, does not derive its inventory based on fashion trends, nor does it position itself as a mass-market brand.
Investment Thesis - LONG
RH was on a tear pre-covid by capitalizing on more people wanting quality products at a good price while also making their galleries a destination spot to lounge for a drink or grab some food.
The stock took a tumble beginning in March when it lost 65% of its value and was trading at $82 a share. As of recent, it’s hit an all-time high of $733. A ~%800 return in a year.
RH has been benefiting from an unforeseen tailwind caused by the pandemic: people stuck at home were bored and saw this as an opportunity to redecorate their houses. Those that recently bought a home also had to spend money to furnish their home. A double whammy.
With this, the company has smashed through earnings over the last year and is continuing to expand its e-commerce business and now benefits from the reopening of its numerous galleries.
RH has shown that it could execute well during a downturn and with normalcy slowing coming back, the company will benefit from its domestic operations as well as its push overseas.
RH posted impressive first-quarter sales and revenue growth. EPS soared 285% to $4.89 a share, above estimates for $4.03. Revenue surged 78% to 860.79m, also beating estimates for $752m. RH's operating margin shot up 14.5 percentage points to 21.8%.
RH now sees Q2 sales climbing 35%-37% vs. analyst views for a 26% gain. Full-year sales should climb 25%-30% vs. its prior target of 15%-20%. The company also gave bullish operating margin guidance for Q2 and the year.
Galleries = gold mine
One of the best parts of RH’s business is when it introduced its luxury galleries to its customers. People were able to go into these galleries (basically showrooms) and see the products firsthand and also a lounge to have a drink or stay for the food.
RH is executing a multi-year retail concept transformation that involves closing smaller legacy stores while opening larger footprint design galleries.
Management is focused on creating a unique experience in their stores, so much so that the new stores are not really stores, but more of an integrated and enjoyable hospitality experience.
Even with COVID limitations still taking place in certain parts of the country, the company believes that the strategy to open new Design Galleries (vs. its smaller, Legacy style stores) in every major market will generate a business of $5 to $6bn in North America alone.
Design gallery economics are far superior to legacy stores, yielding on average +100% sales lift, and +10-20% direct lift, significantly expanding RH’s market share.
The Company opened 2 design galleries in FY20 and has several planned for FY21. Once the pandemic-related interruptions have subsided, plans of 5-7 openings annually will help RH reach its over 70+ gallery target.
It plans to open a gallery in Paris in the fall of 2022 on the famed Champs-Elysees. RH has also secured five locations in London, Munich, and Dusseldorf, Germany.
One word - international
When you cater to the wealthy and you’re already doing very well in one area, naturally you’ll want to replicate it in another. In this case, it’s abroad. This is exactly what RH is planning on doing as I mentioned previously about them opening galleries in the UK, France, and Germany.
The launch of the brand internationally increases its overall TAM and provides a long-term runway for growth. The total European addressable market for luxury furniture is estimated between ~$40-$43bn.
“We believe that RH has the potential to become a $20 billion to $25 billion global brand in its current form and possibly larger if aspects of our ecosystem become meaningful revenue streams. Our view is the competitive environment globally is more fragmented and primed for disruption than the North American market. And there is no direct competitor of scale that possesses the product, operational platform or brand of RH.” - Gary Friedman, CEO
Management has noted that the demographic profile in the U.K. is similar to California, where RH does ~$500m in annual sales with only one store.
Under conservative estimates, U.K. revenue (physical + direct) in year one could reach ~$160mm, and expand up to ~$450mm once RH opens its second gallery.
For reference, +$160m revenue is +6pts of topline growth on FY20.
Margin improvement and operational efficiencies
Management has made it a priority to get operating margins into the double digits. With its most recent earnings showing that they obtained over 20% operating margins, the line of sight to 25%+ operating margins over time from 14.3% in FY20 is within reach.
Continued optimization of its operating model driven by:
Higher AUV mix as RH continues to elevate its product assortment.
Vertical integration of home delivery – fewer returns and lower transportation costs.
Fixed cost operating leverage as the new design galleries carry significantly higher productivity levels.
Transition to a capital-light real estate model – lower rent expense, and depreciation.
Easing headwinds from hospitality and waterworks de-leverage over coming years.
Every 100bps of operating margin expansion is ~$1.10 EPS.
Operational and investment efficiencies will result in a lease-adjusted ROIC of 44% by FY22. This will be driven by operating income growth and a capital-light real estate model. As RH opens more galleries, they will become more capital efficient resulting in lower capex, rent expense, and depreciation.
The company recently completed its first two sale lease-back deals in FY2020 which yielded ~$49mm of proceeds and favorable lease terms.
RH appears to be resilient to market swings because it caters to wealthy shoppers who are less exposed to economic downtrends.
The wealthy are always more likely to win in recessions, as NYU economist Edward Wolff has found. During recessions, wealth and income inequality grow. And as economist Hilary Hoynes and others have discovered, poor and indebted households are affected much more by business cycles.
RH's business model was built to deliver high margins. For example, the company is not susceptible to the usual risks for other retailers that can pressure the bottom line, such as seasonal inventory. Plus, RH serves customers who have money to spend, so it doesn't rely on discounting inventory during a slow economy to drive sales.
Boosting shareholder value
This one is a quick point but if you haven’t already been impressed by how well RH is operating its business, they also have about ~$450m remaining of its $950m share repurchase program as of May 1, 2021.
As I’ve laid out in this entire post, RH is a very simple business with a lot going for it. Having benefited from the pandemic to achieving a premium brand image, customers that shop with RH are incredibly loyal.
Even in its most recent earnings, management has increased full year outlook for revenue growth in fiscal 2021 to a range of 25% to 30% vs. prior outlook of 15% to 20%. They now expect adjusted operating margins in the range of 23.5% to 24.3%, an increase of 170 to 250bps vs. prior outlook of 100 to 200 bps, with an ROIC in excess of 60%.
With the grand reopening and plenty of money in the wealthy’s pockets, and not so wealthy, I’m betting that not only will people continue to shop at RH but take part in all its hospitality services.
With this, I expect FY’21 EPS to be $22.74 and FY’22 to be $25.94. This implies a current FWD P/E of 28.7x and 25.1x vs. analysts expectations of $22.55 and $24.98, or 28.9x and 26.1x.
However, with EPS growth hitting triple digits from FY’20 to FY’22, I believe that RH deserves a premium on its multiple rather than trade in the range set on by the peer set above for the varies reasons I listed prior (high growth, margin expansion, EPS growth, international expansion, grand reopening, etc.)
*Note: I left out Bed Bath and Beyond because its now a meme stock and completely unpredictable.
Though international expansion is in its infancy, the long-term growth potential, with a supported macro tailwind, is poised to in theory create another RH level of business abroad.
With EPS expanding rapidly compared to peers, this is why I’m basing my PT on a more aggressive multiple of 29.0x FY’22 P/E on $26 in EPS. This yields a PT of $754, or ~15% upside from last closing.
I actually covered RH briefly in my investment banking days back when it was trading around $120. The business was so solid, and still is, and caters to a different kind of clientele that can either afford it or will spend the money to appear that they can afford it.
My old roommate put me on to them when it came to bath towels and I haven’t looked back since. I will forever buy my bath towels from them exclusively and when I have some more money, dabble in some other high ticket items to furnish my future apartment. Until then, I will be a shareholder of the company and watch as it strategically grows domestically and internationally while executing on its mission to deliver massive shareholder value.
*The current stock price at the time of this article: $646.11.