Stock Report: Restoration Hardware (RH)

THE HEDGEYE EDGE

We think that RH is to home furnishings what Ralph Lauren is to Apparel and what Nike is to Athletic Shoes. It's the preeminent brand in the space, and sets/leads consumer style trends/wants/needs but with very little fashion risk. From a maturity perspective, we think that RH is 5-10 years behind RL, and 10-15 years behind NKE. Its got the runway. And even though it has such minimal market share across its categories, the competitive set is actually not very strong, and it is creating high competitive barriers.

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

There are some intermediate-term trends worth noting.

1. RH announced last quarter that it is launching two new businesses -- again.  Does this sound familiar? In RH's first quarter out of the IPO gate it announced the launch of RH Tableware, RH Objects of Curiosity, and RH Fine Art. Now we've got RH Kitchen and Tableware and RH Antiquities. Both of these are massively fragmented businesses and present huge opportunities for RH. These are in addition to RH Leather and RH Rugs, two new catalogue drops this fall. #growthaccellerating
2. RH managed to snag Richard Harvey from Williams-Sonoma to be CMO for RH Kitchens and Tableware. The simple fact that RH's share of this category is close to zero today, and they went ahead and hired the person with the best track record in the world in brand-building, sourcing and merchandising in the kitchen space….that's just huge.
3. RH is fresh off the ICSC conference in Vegas and it proved to be a game-changer for the company. They not only had far better success in finding landlords/properties to fit their new Design Galleries. But they found that there are more opportunities for larger properties (as large at 50k square feet) at far lower prices than their business model originally called for. Not only does it take up the number of Galleries we're likely to see over time (over 50), but we think it also takes up the average size per store. These two factors are a critical on a combined basis as it relates to our margin of safety on the RH growth algorithm (see below). With more favorable availability of sites comes more favorable rents and cap rates -- it's economics 101.

LONG-TERM (TAIL) (the next 3 years or less)

One thing that makes the RH model stand out is the growth algorithm over the next 5-years. Specifically…

1. Square footage has not grown for five years. But RH should finally start to report square footage growth starting in 3Q13 – at which point it should start to climb aggressively.
2. But our point is that today it is the comp that's driving the model. We can clearly see where that's coming from.  We can map out additional sales as new businesses come on line, and we can draw out the comp curves for new higher productivity entering the comp base and hitting more mature productivity levels. We're modeling sales per square foot going from $846 last year to just shy of $1,500 in year 5.
3. Ultimately, comps will slow. It's a mathematical certainty. But at the time comps slow we're likely to see square footage growth accelerating to peak rates of growth. Square footage is shrinking slightly today, and should be up at a rate near 20% by year 3.
4. So you see…we can safely model the comp today due to reasons discussed above. Then as that starts to level off, we have square footage ramping up. We can safely model that too. As the second chart shows, that gets us to just over 20% annual revenue growth with comp and square footage flip-flopping their importance to the model as time passes.

ONE-YEAR TRAILING CHART