Great quarter from RH relative to expectations. But there was plenty for both the bulls and bears to chew on. Headline EPS of $5.67 vs the Street at $4.70 and our estimate of $5.25. Definitely played catch-up on backlog and fulfilled orders this quarter that were delayed last quarter. The company took up the lower end of annual guidance, but when you do the math it suggests 4Q slightly worse – particularly on Gross Margins of down ~100bp with the Street +30bps. The biggest bearish takeaway is the number of times in the conference call that Friedman stressed that ‘the housing market is in a freefall/collapse’. That’s not new by the way, at least not for him. But he stressed it more this conf call. He’s the only one out there that has the stones to tell it like it is. That’s already baked into our forecast by the way, which is coming out ahead of guidance/consensus. The only thing that bugged us this quarter is that the company only repo’d ~$30mm in stock this quarter vs $255mm in 2Q (at $255/sh). The company made two acquisitions this quarter, in the vertical fabric supply business and another to launch RH Media – both to secure better economics in the supply chain, availability of product, and then have a Global platform to express to consumers how it’s ‘climbing the luxury mountain’. Also, Friedman has a mandatory exercise of ‘use ‘em or lose ‘em’ options, which we suspect will be done very quickly. But optically the company is conscious of negative optics around buying back while the CEO is selling (to satisfy the tax obligations). But in the end, we think that the company is looking at business as getting worse before it gets better, and it ‘knows’ it can buy back stock lower. We wouldn’t disagree. We have the company buying back $2bn in stock at an average price of $350, for what its worth, which gives us $8ps in EPS accretion. If we see it buy back at $200, we get to over $14ps accretion.
Longer term, the company’s foot remains massively on the accelerator with growth – both in the US and Internationally. Management admitted what everyone knows, that Contemporary has been selling very well, but the broader roll out is constrained by supply availability. It sounds like Contemporary roll-out should accelerate starting in 1Q23 across a broader number of galleries, and then be an anchor in the toolbox for Europe. By our read, there was a slight push of the Paris Gallery from fall ’23 to Spring ’24, with 2024 now being the big year for openings in Europe – with up to four galleries being opened for the year. RH England remains on track to open in 1H23.
As for the stock, if you’ve got duration, we think this stock is a slam dunk starting with a $2-handle. Could it go to $200 when we think the retail space collapses in 1H23? Yes. But we’d be VERY surprised to ever see this stock start with a $1 ever again. If so, we think the company will be buying the stock hand over fist. We still build to $60 per share over a 3-5 year duration with the Street at $30. We have a HIGH degree of confidence that Europe will be a slam dunk for many reasons – and that’s the biggest pushback we get over this name. The company is ‘going native’ in Europe – with different designs and aesthetics for each store in each country for the consumers that live there. The company has been studying Europe for 10-years. Unlike the US market, which has a homogenous consumer, every country and even region in each country has different consumer tastes (ie RH England vs RH London – COMPLETELY different customer), and RH is planning merchandise accordingly. It’s also even more fragmented a market in Europe than in the US. It’s ripe to be consolidated at the high end – and RH will be the one to do it. Also keep in mind that 80% of RH’s designers are European – something people often overlook.
Ultimately, if our numbers are right, this is well over a $1,000 stock over 3-years, and closer to $2,000 over five. That might seem tough to believe today with abysmal demand dynamics and management’s ominous caution. But we think RH will be revalued as a luxury brand as it comes out of this cycle with 40-50% of the adjusted float taken out and ‘proof of concept’ in Europe is in the bag. Don’t underestimate how big the Global roll out is to the valuation and earnings power of this company.
Tactically, we’d definitely own ‘some’ RH here, and would be more than happy buying higher – like in the $350 range, which is where we (conservatively) have the company on average executing its buyback. This was the first name to trade down as the cycle started to roll, and we think it will be the first name to recover when it turns. The moment the cycle ends it bottoming process, we think the big tell will be Gary buying stock personally, which will make this name rip.
The risk is that this is a drawn out slowdown and prolonged bottoming process in home retail, which is not in our model. But we’re of the view with all Home-related names that the fastest collapse in housing demand in history will mean an intense and compressed decline in comps and margins, as opposed to a 2-3 year slow-bleed downward comp cycle that we saw in the GFC. RH is telling you the former is happening, but no one else is, which is why we’re short LOW, HD, FND, WSM and ARHS (all Best Idea Shorts). So much room for earnings to decline in those other names – most of which are at peak margins. No change to our estimates this year or next for RH. We’ve already baked-in the recession. We’d pair RH off against virtually everything else in the Home space right now.
Here is the link to a replay and slide deck for our October RH Call Link CLICK HERE
