RH put up an absolute crusher of a quarter. We were looking for the company to push $5.00 per share vs the Street at $3.99, and it came in at $4.89. Strength was across the board, demand strong with 78% revenue growth, gross margins up 593bps to 47.3%, and disproportionately low SG&A spend at 23.7% of sales (no need to spend up when demand is so hot). So from an earnings standpoint, everything checks out. If there’s anything I’m starting to worry about it’s that there is so little controversy on this name right now. In listening to management’s articulation of its long-term strategy over the years, it has been remarkably progressive, both evolutionary and revolutionary, and most of all, consistent. The problem in listening to the Q&A is that people seem to finally believe them. We still only have about 50% of the sell-side with a Buy rating on the name, so that’s a plus. But I look at the short interest on the name and its down to 14% of the float, most of which could be explained away by delta hedging against the converts. Mind you, this is a name that sported 50-60% short interest just two years ago when the stock was 1/3 of where it is today. People have always loved to discount this management team, but it finally seems to have earned its cred. Congrats to the team on that front – consistency always wins in the end.
But the one major hole I can poke in the sentiment set up is that over the long-term, people don’t believe the top line. I think people buy into the 25% margin target – the company is earning the Street’s respect as a luxury brand with luxury margins. But what people are missing is the magnitude of top line growth that the company can, and will, pump through this model over a TAIL duration, with disproportionately little capital. If you want to get paid next quarter or next year, there’s probably a good 30% in it for you. Not too shabby in a space where consumer companies are smoking numbers only to face down earnings next year and see the stock get clobbered accordingly. But we have RH blowing through $6bn in revenue over a TAIL duration, while the Street is stuck below $5bn – and we think that’s going to make all the difference. Let’s face it. RH already has a pseudo-luxury multiple. Mission (pseudo) accomplished. But it doesn’t have luxury white space growth embedded in expectations as the only luxury home furnishings brand with scale on the planet – at a time where it will be opening up countries left and right. In fact, our $6.3bn revenue number in year 5 of our model seems low to me. That should be the run-rate for the US alone. It’s going to absolutely dominate Europe, then tackle Asia and the Middle East (potentially through JVs – that remains to be seen).
The punchline is that we’re at $25 per share in earnings this year. That’s nice…but again, it’s not what gets you really paid on this name. You need to dream the dream, and trust that this management team will execute on it. The market is starting to dream, but they’re simply not manifesting that dream in estimates. Over a TAIL duration we’re at $42 in EPS, vs the Street at $32….and I think our top line estimates are hardly aggressive. We’re just shy of a 25% margin level, as we’re accounting to additional marketing spending when demand normalizes in the US and the company needs to spend more – as well as what will likely be a ‘go big or go home’ approach to marketing in and dominating the home furnishings market in Europe – which puts the fragmentation we have here in the States to shame. There are good home furnishings retailers in Europe, but on average they operate 2-3 stores with minimal e-comm presence. RH is going to go-in with 60,000 square foot galleries and literally blow people’s minds as to the breath and depth of the offering, as well as the below-market prices it can charge due to its global size and scale. It’s nearly impossible to compete successfully with that kind of dynamic.
So in the end we’re left with $42 in EPS power, 25% EBIT margins, no debt, roughly ~$125 per share in net cash on its balance sheet (in year 5), and 60% cash-on-cash returns in a global growth category where it has no pure-play competitor to speak of, and enormous barriers to entry. The question then becomes what that is worth. All I know is that its not the 14x earnings and 8.5x EBITDA multiple that it currently is sporting on our long-term earnings and cash flow estimates. There’s definitely a host of price discovery to come on this name, but from where I sit a multiple of 30-40x earnings on this type of story is by no means a stretch when dominant players like Nike trade at that level on an average day. LVMH (which should acquire RH, if RH lets ‘em) trades at 36x earnings and 5.7x sales. That multiple on RH over a TAIL duration suggests a $1,200 stock. A 40x EPS multiple gets you closer to $1,700 – or about 26x EBITDA. Get the drift? That’s not in today’s dollars, but it’s in the cards if you want to take a ride with this company as the business model evolves. Even if we discount earnings and cash flow by an aggressive 15% rate (after all, it’s an aggressive plan), it suggests about $900 per share in a year.
I’d be surprised if it actually hits that level in 12 months, as the company is going to have to show success in opening up new countries to prove the top line consistency and momentum, and that will take 2-3 years. But we’re been here for the ride since $28 – and this ride is far from over. There’s no better ‘buy the dips’ name I can find in retail than RH. This team’s strategy is going to make long-term shareholders a lot of money.
