We noted in our preview that RH management was likely to throw a wet blanket on the demand outlook given recent volatility in the market – which has a direct correlation to how much the wealthy have the propensity to drop $100k-$200k in (re)furnishing a home. These events have proven to be deferred, rather than forgone purchases, but still…a delayed sale is delayed revenue, and the market has zero patience for that. RH put up a good quarter, with the top line growing 11.1%, the 2-year stack up 33.3%, and EBIT margins an impressive 152bp above last year to 24.1%. EPS clocked in at $5.66, slightly above the Street at $5.59. But the outlook definitely fit our ‘wet blanket’ narrative.
On one hand management was extremely bullish about 2022 initiatives such as the launch of RH Contemporary, the opening of 3 galleries in the US, the launch of Guest House, RH Color, RH Residences, and particularly RH Europe. RH England is baked and is prepped to open this summer (a slight push as previous guide was for a late spring open), but RH has also secured locations in London, Paris, Munich, Dusseldorf, and are currently in negotiations for properties in Milan, Madrid, Brussels, and France. Without question, the company has accelerated property acquisition plans to launch and then rapidly accelerate growth in Europe, which we think is even more ripe for consolidation at the high end than the US market, with a multi-billion runway for top line growth over our 5-year modeling time horizon at an accretive EBIT margin.
Gotta give credit to Friedman on this call. He was super pumped about the growth initiatives on one end (as he usually is), but was amazingly ‘Macro Aware’ on the other. He pulled no punches about policy gaffes by the Fed, rising interest rates, generational lifts in inflation and the need for virtually all categories of retail to raise prices or eat the margin, the questionable sustainability of record high home prices that we see in the market today, and the impact of the war in Europe and its impact on market volatility, the wealth effect and consumer confidence. Yeah, he went off a little on Yellen and Powell on the inflation – probably a little too much. But it was flat out refreshing to hear a CEO of a company have such a strong understanding and view as to the Macro cross currents impacting the business. He came across – at least to this analyst – as extraordinarily honest and believable.
That brings us to the guide…which is for sales growth for the year of 5%-7%, well below our model and the consensus. Let’s face facts…Friedman is no dummy. With his stock price in the tank, and the Macro uncertainty – nobody would believe him if he gave a more robust top line guide anyway – so he erred on the side of conservatism. We think the company comes in better than 2x that level, and then accelerates into the next year as Europe is fully open and taking share in what is likely the most fragmented high-end home furnishings market in the world. Given that it has no legacy ‘down market’ brand halo to shake – it’s starting from scratch at the ultra high-end – we think that pricing in Europe will be 20-30% higher than the US on like for like items. As such, we have margins going up as Europe scales as opposed to other companies that use dilutive distributor models to grow into Int’l markets. On top of that, we have the company buying back $1bn in stock this year at prices ranging from $350 today to $550 by the end of the year. The cash profile of this company is astounding, and with a capital-light model as it relates to new store builds, it will have a ton of cash to return to shareholders. We’re modeling $1bn per year, but in typical RH fashion, we can see it buying back a lot more stock a LOT faster than we’re modeling.
As it relates to Europe, we think that once there’s ‘proof of concept’ it puts RH in play by the likes of LVMH or one of the premium European luxury houses – compared to which RH has similar margins and superior returns. If we don’t see interest from a strategic buyer, we wouldn’t put it past Berkshire to buy the company outright. To be clear, we DON’T want to see this happen! Even at a 100% premium a deal would get done at what…$700? That robs shareholders of what we think is massive upside over a TAIL duration. If you own the stock, you want this company to continue to scale up high-margin and high-return growth in a space where it literally has no real competition and a tremendous competitive moat. Looking out several years, this reminds us of when we called for RH to be a $300 stock when the name was ~$50.
Are we concerned about management’s comments about the choppy Macro climate? Yes, particularly given that we’re in Macro Quad 4. We’re staring down the barrel of the toughest compares from a consumer spending standpoint in a generation over the next two months. But RH just reset the bar lower, and based on the muted sell-off the market was expecting it. Now we have a litany of growth drivers in 2H, just when we’re in a more favorable Macro climate to own consumer discretionary stocks like RH, and should simultaneously see deferred purchases from 1H accelerate growth in 2H (along with all the initiatives noted above that should drive the top line).
Click Here for more details on why we think there’s outsized top line upside in this model from our Black Book that we presented earlier this year.
