With this print at bat, it was a strike out swinging for McGough in getting this RH print wrong. I thought we'd see EBIT margin of 13%, and we saw barely half that. I don't listen to any management teams in making forecasts -- ever, including RH. We thought we had found a bottom in 2023 earnings expectations, but clearly we did not. Management equally surprised by the margin level this quarter and into 4Q. Though the rate direction has completed a bearish round trip as it relates to recent demand, ripping into late September to mid-October, then back over the last month or so. With the disappointing print we thought the stock reaction might be worse than the initial 8-10% decline in the stock after hours...it could easily be down 20%. But as we say at Hedgeye, bottoms are processes, not points. When all is said and done, we think people are going to point to 3Q23 as being near the end of the bottoming process for this name.
Mind you, the home furnishings space has been in a recession for the better part of two years. Not that Friedman has any credibility over a TRADE/TREND duration (nor do I) but in my career, I've never seen a company -- in any industry -- invest so heavily in a down cycle. The number of galleries and design centers -- measured in both number and aggregate square feet – being added in 2024 will beat any year of growth RH has done in its history. Add on the broader launch of Contemporary, the complete redesign of the Core RH aesthetic (first time in 8 years), RH Interiors, Outdoor, Color, and then some...and this company is investing massively in a downcycle. To be clear...management does not give a crap about hitting this quarter or next quarter's numbers. I care, but management doesn't. If there's one thing I've learned in 30-years of investing, it's to bet on quality management teams when they invest when peers are pulling back on PP&E and SG&A. That's when there are simply massive market share gains at powerful incremental margins—growth of upwards of 5x that of peers on an organic basis -- but not driven by discounting, which is likely here to stay for competitors. Note...short WSM, ARHS, LOVE...and pair 'em all against RH. Could this stock re-test the lows for the year? Yes. Every stock has downside, and here it's likely close to 200. But across a TAIL duration, I literally think this stock has over 1,000 upside from its current ~250. The earnings power here is higher than anyone is expecting.
Let's not even go into the torque this name has if rates come down or if the housing market returns to any sense of normalcy. Same for B2B. We could be looking at 10-20% recovery comps on existing stores – never mind all the new square footage globally...and the upside leverage to this model is massive -- and far outweighs the downside that we see from here under even an even more beared-up scenario than we're currently seeing. Now, leverage works both ways. We need to acknowledge that. If rates head higher, then we'll look like geniuses on our shorts on LOW, HD, FND, TSCO, WSM, ARHS, LOVE and POOL -- and RH buying 17% of its stock at 326 will look like a foolish move. But the biggest risk is International expansion. Not whether it succeeds or fails -- because it will work. The question is how much the company has to pay in brand marketing to MAKE it work. THAT's the real risk to our estimates and our thesis -- not the housing market.
TREND Callouts
The P&L rate of change setup from here is glaringly bullish. Top line we think goes from -14% in 3Q to + high teens by 4Q24. Gross profit accelerates alongside going from down 20% in 3Q to mid to high 20s in 2H24, and EBIT slows into 1Q24 on the source book shift, but grows upwards of 75% in 2H24.
Stores/Markets. The store growth ramp here and its contribution to revenue is significant. England opened in summer, the 2 Germany stores just opened a couple weeks ago. 5 US Design Galleries are on the docket for 2024 (3 in 1H and 2 in 2H) as well as 3 international galleries, Brussels, Madrid, and Paris, all of which open new countries/markets, not just new stores. Plus a design studio in Palm Desert. 2024 should be one of the biggest topline accelerations RH has seen and one of the best in all of retail.
Domestic Demand. We’re matching the domestic demand cadence to our view of home retail, where we think demand remains under pressure until around mid 2024. New US stores should still drive topline acceleration even with comp demand not showing improvement until 2H. We were previously modeling the US recovery for the RH consumer base to start earlier, now that’s partially shifted into 2025.
Clearance. The company appears to expect to have elevated clearance into 2Q24, we’re modeling in that margin drag but think 2H is the peak of clearance.
SG&A Step Up. SG&A for 2024 is going up in our model, the company shifted its Modern source book drop to 1Q24 which we think is around 30 to $40mm shift. Plus the company is brand building around stores in 4 new markets.
We’re Bullish on International. The commentary around the early international stores was directionally bullish this Q. Management highlighted the orderbook continuing to grow at RH England despite worse weather. And the initial reads on Germany stores sounds more bullish than the initial RH England take given the elevated traffic flow to these stores located in core luxury shopping streets vs the English countryside. We think the revenue ramp for these international stores and market will exceed what’s implied in consensus estimates looking into late 2024 and beyond.
Repo. The company repurchased another $45mm in stock this Q at about 238/sh. We are modeling another $250mm in repo 1H when the P&L likely starts to inflect materially to the upside.
We will have a Black Book on this name before year-end.
