RH: Accept The Gift

Takeaway: Every single bear case - especially dot com concerns - was just blown out of the water. Fundamentals look phenomenal. Embrace the CEO trade.

Conclusion: This sell-off is a gift.  The departure of Carlos Alberini is not the end of the world. The C-suite is crowded. They need a warm body in there when they start opening mega stores in 12-18 months. They've got time. Our long-term estimate is going up to $10 from $8.50. The market will do what it wants as it relates to this announcement. But we can confidently say that for long-term investors looking for the rare triple over a 3-4 year time period (not many of them out there), we'd recommend buying into the pessimism, and accepting what we thing is an early holiday gift.



This is as polarizing a quarter as we've seen from any company in a while.


Obviously, RH announcing that Carlos Alberini is moving on is not good news. There's no way we'd try to sugar coat it. But consider the following.

  1. Co-CEOs don't work. They never have, and they never will.
  2. The only reason why Carlos has 'CEO' on his business card is because Gary Friedman was forced to step down and take a different role due to his extracurricular activities. THAT's when Carlos got what he wanted -- the CEO role.
  3. But less than a year after stepping down, Friedman stepped back up again and told Carlos that he'd need to share the top job. Probably not a good day for Carlos -- especially given that he spent well in excess of 10 years playing second fiddle to the Marciano Brothers at Guess and was ready to be THE man.
  4. And make no mistake -- title or no title -- this was Gary's company. In fact, if it were Gary who was stepping down right now, we'd consider it an absolute thesis-changer.  He's the brains behind the plan to get to $10 in earnings. Carlos was good, but he is replaceable.  In fact, we'd argue that Karen Boone (CFO) is less replaceable than Carlos.  The guy is good. Really good. But they have a CEO, COO, CFO -- and though they'll probably get someone to replace Carlos (it's a pretty appealing job -- many will want it) they can certainly continue to execute without him.
  5. Where we really viewed Carlos as being critical is when the company starts opening significant numbers of 40k-50k square foot stores. That's where we thing Gary's expertise starts to run its course, and RH needs a proven retail store growth expert.  Gary is not replaceable. But finding someone to execute on store openings -- while a very hard job -- is something that has a pool of many hundreds of people that could do the job.
  6. Lastly, Carlos will remain on the Board of RH. We question how long he'll last given that being CEO of Lucky is like two full full-time jobs. But at least until the store openings start en masse (in 12-18 months), and until they have an extra head to execute on the rollout, they've still got their hooks in Alberini.



Now let's hit on the good news…and that's pretty much everything else.

The quarter was phenomenal. The company beat on the top line, gross margin, SG&A, and, of course, EPS.

The big stat was the RH Direct was up 47%.  We only have data going back 5-years -- but we can't find a quarter where it was up remotely that high.

The key, of course, is all the noise investors made over the past two weeks about being weak because of the elimination of the Fall Sourcebook -- and weak ComScore data pointed to a precipitous dropoff in the numbers.

We looked at things a bit differently. We tracked's internet traffic ranking over the past six months -- and while everyone else thought the Direct business was falling apart, we saw's traffic rank improve by better than 35%. How can the business be losing momentum when we're seeing such strong numbers out of's traffic rank?  Anyway…that's what we argued earlier this week (see our analysis below), and it proved to play out in the company's financial results.


We're not changing our estimates for store growth, comp, but we are tweaking higher our gross margin forecast. We had been assuming a relatively flat gross margin over time (steady at 36%), but now we're looking at something closer to 38%. Simply put, as product mix changes, it will move to higher margin product that turns faster. So not only do we get to a $5bn business at a 14% EBIT margin, bus also one that has an ROIC profile that goes from 12% today, to near 30% in 5-years.


The punch line is that there's nothing we can do about the pessimism surrounding Alberini's departure. But we can confidently say that for long-term investors looking for the rare triple over a 3-4 year time period (not many of them out there), we'd recommend buying into the pessimism, and accepting what we thing is an early holiday gift.






RH: Our Take On The Market's Bearishness



We've never seen the Street more bearish on RH -- especially headed into a print.  We find that interesting, if not perplexing, given that there should be such a positive change in fundamentals with the upcoming quarter. We still think RH is on its way to $175. The quarters will ebb and flow. But despite the bearish sentiment we like it into the 3Q print.


Consider the following

Last quarter -- when RH was flirting with $80...

    1. RH missed the comp -- coming in at 'only' 26% versus expectations of something well into the 30s.
    2. RH continued its string on new business announcements -- but instead of announcing businesses that are actually commercially viable, it came out and announced that it would  start RH Music and RH Hotels (whereby it would outfit a small number of niche hotels with RH garb). The company made a mistake in announcing these -- even though it only cost them about $5mm annually out of the $35mm they saved by not producing the Fall sourcebook -- it was really more of a marketing initiative than a new business initiative.  All they succeeded in doing is scaring the lights out of Wall Street about their strategic direction.
    3. Gross Margins were off by 253bps, the biggest decline RH experienced since 2009 -- when it was in the tank.
    4.  They announced the elimination of the Fall sourcebook -- which caused a not-so-minor freak out by investors who were concerned that the company's Direct (non-store) business -- which is about 47% of total -- would start to evaporate.
    5. Shortly after the print, the three 'founding shareholders' who took it private and subsequently public all sold out simultaneously (the structure of the deal required that they all move in tandem).
    6. Then as a kicker there was one extremely bearish sell-side initiation with a Sell rating due to structural reasons -- arguments that we think are weak at best (we'll debate them anytime). Then earlier this week, another firm was out talking about how weaker ComScore data suggested that sales were falling.


Package that all together, and it's easy to see why sentiment is so poor.


But here why we're more optimistic…

    1. We think comp will accelerate meaningfully this quarter -- from 26% to something well north of 30%. The company did not articulate as well as it should have that comps were weak because it simply did not have enough inventory. Part of that was that product was on the water for 2-4 weeks longer than expected, and as such they could not recognize revenue. That revenue will show up in 3Q. Is the supply chain issue fixed? No. That will take the better part of a year. But we're convinced that the problem has not gotten worse, and in fact has started to improve.
    2. Gross Margins should improve dramatically this quarter -- from -253bps last quarter to better than -100bp this quarter. We would not be surprised to see it closer to flat.
    3. As it relates to, we're simply not as concerned as everyone else seems to be.  We think that the following chart flies in the face of those who think that the elimination of the sourcebook hurt revenue. Specifically, it shows the traffic trend at RH over the past six months. To be clear, you want to have a declining traffic rank (Facebook is #1,  Nike is 972, and Saucony is 77,500). The point here is that's traffic rank improved consistently from 15,000 down to 10,000 over the time period that people are worried that RH's web business dried up. 


RH: Accept The Gift - 1 



RH: Accept The Gift - sourcebook



RH: Accept The Gift - whatpeople do with catalogues



Sentiment for RH is just about as low as it's ever been  -- despite the fact that fundamentals are getting better on the margin, and we’re inching closer to the period (in 12 months) when square footage should start to accelerate.


RH: Accept The Gift - 11

RH: Accept The Gift - rhsqftge





Extended (Again): SP500 Levels, Refreshed

Takeaway: There’s mean reversion risk down to 1734 TREND (-4.1% downside) versus +0.4% upside from the all-time closing high of 1808.

This note was originally published December 10, 2013 at 12:41 in Macro



During the 5-day correction in the SP500 (which ended Thursday) I went to 11 LONGS, 3 SHORTS. So all I am doing here is aggressively managing the immediate-term risk of this market’s range. #GetActive remains one of our Top 3 Global Macro Themes for Q413.


Unconventional markets call for unconventionally active risk management.


Across our core risk management durations, here are the levels that matter to me most:

  1. Immediate-term TRADE overbought = 1815
  2. Immediate-term TRADE support = 1785
  3. Intermediate-term TREND support = 1734

In other words, the immediate-term risk range = 1785-1815 and, from an intermediate-term TREND perspective, there’s mean reversion risk down to 1734 TREND (-4.1% downside) versus +0.4% upside from the all-time closing high of 1808.


The less I try to over-think this, the better. The math works more than it doesn’t.



Keith McCullough

Chief Executive Officer


Extended (Again): SP500 Levels, Refreshed - SPX

Seen the $VIX Lately?

Takeaway: This equity market is as complacently positioned as I have seen it in six years.

Equity volatility starting to look primed to breakout into 2014.


After making a series of higher-lows since August, front month VIX (volatility) broke out above our Hedgeye TREND resistance of 14.91 yesterday.


Fed confusion is going to breed contempt.

Seen the $VIX Lately? - VIX

This equity market is as complacently positioned as I have seen it in six years. Yesterday’s II Bull/Bear survey hit a fresh year-to-date high of +4390 basis points to the Bull side!


Editor's note: This a complimentary excerpt from Hedgeye CEO Keith McCullough's research this morning. Click here for more information on you can subscribe to Hedgeye research.

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Takeaway: We are getting increasingly negative on the slope of domestic economic growth.

Yesterday, Keith and I did a full slate of meetings with funds in NYC; without violating any confidentiality by getting bogged down in the details, here are the key takeaways we were effectively pounding the table on:


  1. We still like our #EuroBulls theme (CLICK HERE to launch our @HedgeyeTV video) and continue to see opportunities on the long side of European growth equities. We continue to like the UK and GBP then Germany and EUR in that order.
  2. Based on early warning signals, we think 3Q13 is a cycle-peak in the sequential rate of US economic growth. If we were mandated to allocate capital to US equities, it would be in high yield, slow growth, low short interest and/or commodity-linked stocks, at the margins – basically a return to the 2011-12 playbook. The UST 10Y yield has probable downside to 2.5% in this scenario.
  3. A potential 1H14 macro theme we see developing is inflation-hedge/consensus yield chasing plays continuing to make higher-lows alongside US equity volatility (CLICK HERE to launch today’s @HedgeyeTV video on a potential breakout in the VIX). That list would include gold, commodities, emerging markets, TIPS and REITs. The Abenomics trade (i.e. short JPY/long Japanese equities) would make lower-highs in this scenario.
  4. Fund flows have the opportunity to buoy the US equity market well into 1Q14, though we’d expect growth data to be decidedly cooler by then if the Fed does NOT taper. We are very differentiated from consensus in that we think that a return to prudent monetary policy is the only way to promote sustainably faster rates of domestic economic growth. We don’t buy into the consensus fear-based whining about deleveraging and the perceived risk of higher rates in the housing sector.
  5. If the Fed tapers or signals imminent tapering, we’d abandon each of the aforementioned views and would be buyers of any subsequent US equity pullback. If the Fed does NOT taper (as we expect), we’d be sellers of any subsequent US equity strength.


Today, we received a great follow-up question from a very sharp client in the fixed income space: “What is the data you’re looking at to support your view that GDP growth will slow down?”


As with any inflection-based call on growth and/or inflation, we start with the market’s risk management signals – which tend to lead the reported data. The USD is decidedly broken from a quantitative perspective and long-term interest rates are making lower-highs vs. the YTD peak in both growth data and #GrowthAccelerating expectations.






Moreover, both are declining on a QoQ average basis, which is historically something you’d see during periods of marginal stagflation (i.e. Quad #3 of our GIP model = Growth Slows as Inflation Accelerates).








That reflexive relationship is something we’ve seen throughout the YTD:




As it relates to early warning signals, the ISM data appears have materially inflected here, which confirms what we’ve already seen with respect to the respective trends in consumer and business confidence.








Recall that inventories juiced the 3Q GDP print – which we’ve argued is a healthy, pro-cyclical response to increased business confidence. Well, now said business confidence has inflected to the downside here in 4Q and we anticipate inventories will follow suit when 4Q13 GDP is reported.




Again, our call for an inflection in growth is in the very early innings so you won’t see it in the broad swath reported data just yet – much like you didn’t see a ton of data to support our #GrowthStabilizing and #GrowthAccelerating calls at the start of the year.




I’m guessing to the naked ear we sound about as crazy as we sounded roughly one year ago when we were pounding the table on long side of US equities and on the short side of anti-growth assets (e.g. gold, EMs, commodities, etc.) as the biggest US growth bulls on the street. For now, that’s a position we feel comfortable taking in the absence of a change of heart at the Fed.


Please feel free to email us with any follow-up questions or if you’d like us to forward you the analyses supporting the conclusions laid out at the start of this note.


Have a wonderful evening,




Darius Dale

Associate: Macro Team

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