RH - Real Estate Oppty Grossly Misunderstood

Takeaway: Our analysis suggests that RH stores should be far bigger, and will be much cheaper than the Street thinks. Numbers are too low.

Conclusion: We’ve spent a lot of time on the road discussing RH over the past three weeks, and most specifically, our recent 45-page deep dive on RH’s real estate. The punchline of our analysis is that a) RH stores could (and probably should) get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. This analysis supports our $11 earnings power in five years (double the consensus), as well as our view that that this stock is headed well above $200. Here are some of the slides that we kept revisiting in our conversations.



1. Market Share Trumps Store Productivity: For the most, people underestimate the ramp in RH’s addressable market as the company continues to expand into new categories. Over the next five years, there should be $45bn upside in market opportunity for RH simply by expanding its presence into new categories at retail, including kitchens. An important note is that we analyzed every market of the US, and isolated only consumers making over $100k annually. The government’s aggregate numbers include every income level. But the fact of the matter is that the average American spends $857 annually on home furnishings, while those making over $100k spend $1,779.  


RH - Real Estate Oppty Grossly Misunderstood - rh 2 1


2. Real Estate Methodology. In our analysis, we look at each market at a micro level. That is, we isolate the existing store, and then look at the demographics within a specific driving radius. We look for income levels, home values, and ultimately, how much money consumers at each income level spend on the categories where RH is expanding. This chart below shows Seattle, but we did this for every existing and potential RH market in the US and Canada.


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3. Store can get MUCH bigger. The key to how we model RH is based entirely on market share. There are three factors that mater…store size, productivity, and market share. It’s absolutely impossible to pinpoint any one of those without knowing the other two. We think we can get pretty close. We already know that the highest productivity FLDGs are running at 8-9% share of their respective markets – and that’s before adding new categories like kitchens. Our model assumes that each FLDG hits 10% share in year five of our model, and generates $1,200 per foot (reasonable based on what we’re seeing today). That leaves us with an implied store size. In some markets like New York, it suggests that RH could have a store over 100,000 feet. Same for Houston (we think it expands its existing store). Most people we talk to cringe when we discuss anything bigger than the 20-25k box that we’ve seen built over the past two years. But this analysis suggests that RH could support 30 stores over 50,000 square feet, and all but 5 can support a 25,000 foot FLDG.


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4. New Market Potential. In addition to existing markets, there’s another 19 markets where RH can, and should, build FLDGs. In 10 of the markets RH could add a store 45,000 feet or larger, and the biggest market – Montreal – could support an 80,000 sq. ft. store.


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5. New Store Math is a Slam-Dunk. In this example (Cherry Creek) RH is taking over a Saks and is going from a 7,500 feet legacy store to a 56,000 foot FLDG. Implied market share at the property goes from 1.5% to 4.3% by our math, and despite the incremental $20mm in revenue, rent only goes from $1.3mm to $2.0mm. That takes occupancy costs from 12.6% to 6.5%, and likely lower as the store becomes more productive.  But the key to this algorithm is that there’s $19.5mm in build-out costs, $15mm of which is being picked up by the landlord. Inventory costs in this business are minimal at the store level. So when you add up all the economics of the store, you get to a 6 month payback. It’s tough to find that elsewhere in retail. This leads us to think that our Gross Margin estimates (which don’t go above 39%) are potentially conservative.


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6. Yes, there are more of these opportunities than most people think. There’s still a nice pipeline of free-standing locations – like what RH has in Greenwich, Houston, and Boston. But we’ll see more examples of the mall-anchor space as outlined above in Denver.  Take for example the Cherry Hill mall in NJ. A high-end property with three anchor tenants – Nordstrom, Macy’s and JC Penney. Which one does not belong? JCP has less than half the productivity of Macy’s and Nordstrom, and arguably does not belong in any ‘A’ mall. That’s not where JCP’s customer shops. We think we’ll see more situations where the landlord buys out JCP, takes the space and carves it into 2 or 3 highly productive retailers – who will collectively transform that end of the mall. In this instance, we use RH, and arbitrarily pick CAKE and WFM. That would take annual REIT income from $10.1mm to $23.7mm (see second table below). That makes it pretty easy for the landlord to justify buying out JCP and building a couple million worth of walls, stair cases and escalators. As a point of reference, JCP has about 140 ‘A Mall’ properties. Yeah…big number.


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Still Bullish on Och-Ziff $OZM

Jonathan Casteleyn, co-head of the Financials sector at Hedgeye, briefly explains why he likes shares of Och-Ziff Capital Management, an idea he highlighted in early May.


The USD appears to be breaking out while both the EUR/USD and European equities are sending bearish signals. Both of these moves, should they continue, would be a headwind for Gold.

Last week we released an extensive report outlining the implications of a QUAD #4 (inflation and growth decelerating) GIP set-up through Q3. A link to that slide deck is included below:


What's Next For Global Financial Markets?

We are waiting and watching closely for confirmation on this potential inflection point. Our current view that domestic growth is slowing remains intact. Although with commodity disinflation from the first half of the year and recent weakness in Europe, we are watching this re-tracement closely. Recent data has opened up an internal discussion about the strength of our #ConsumerSlowing theme:

  • Commodity Disinflation
  • Marginally better consumer spending and credit growth combating the absence of a positive trend in real wage growth:
    • Household debt growth has increased from Q3 2013
    • Trailing 12-month nominal consumer spending slightly outpacing nominal incomes (re-leveraging a potential tailwind to consumer spending capacity)

We highlighted developing credit trends in a note last Friday:


Gold currently stands right in the middle of key @Hedgeye TREND/TAIL levels after trading in a tight range last week (with the exception of  a big rally Wednesday front-running Draghi’s speech.) The move suggests the market expected him to announce an asset purchase program. Gold ended the week up over +1%.


@Hedgeye intermediate-term TREND support is at $1271. The long-term TAIL Line of resistance sits at $1323. We would become louder on the long-side if Gold penetrates and holds this TAIL line. The narrative remains the same:


1.       Growth expectations slow

2.       U.S. interest rates fall

3.       Both Gold and Long-term Treasury Bonds rise (holding the monetary policy of other reserve currencies constant over the more intermediate-term a very important factor to our gold thesis that we are watching intently right now). 



Ten-year yields touched YTD lows Friday reflecting skepticism around a sustainable recovery despite the +4.1% initial Q2 GDP bounce. After breaking @Hedgeye long-term TAIL support, 1.70% is the next line of defense. The ten-yr yield is down over 20% from the beginning of the year and currently sits near the lows at 2.43% (2.36% YTD low late last week). Our risk management signals suggest the momentum embedded in this trend makes further downside to 1.70% a more probable scenario than the consensus 3%+ expectation. 




Although this narrative for the USD outlook works both for and against the price of gold under certain scenarios, we continue to believe real growth expectations in the U.S. for the second half of 2014 remain too high. About a month ago we published a note outlining the thesis on Gold’s interaction with monetary policy by walking through its performance vs. other asset classes under different economic scenarios:




Right now there are two big headwinds to our position that will have implications for Gold’s direction:  

  1. The quantitative signals suggest upside for the dollar and downside for the Euro: An apparent breakout in the dollar to the upside coupled with an incrementally more dovish Draghi is a headwind for Gold. The Euro is at a nine month low currently after topping in March of this year. European data is slowing (magnified in the countries which outperformed in the first half), and a majority of European equity indices are breaking down.

Our recommendation is short:

  • European Equities (ETF: EZU)




  1. Weak Europe, Dovish Draghi: The expectation for economic weakness has been somewhat priced-in with expectations that some form of easing from the ECB is right around the corner. The outlook in the U.S. is more uncertain. If growth does miss in the U.S., the fed may get more dovish.. SO MAY THE ECB

Two comments in particular from Draghi last week caught our attention:    

  • Readiness to pull the trigger on an asset purchase program.

 His tone this past week reflected his willingness to stand ready for an ABS purchase program. In fact, he more or less said that he would implement an asset-backed purchase program (QE without the government bond and public asset purchase program). Not a single economist surveyed by Bloomberg expected a change in interest rates from Draghi last week, but the bounce in Gold suggests the market may have expected some kind of easing out of Draghi Thursday.


  • Allusion to divergent policies in the U.K. and U.S. moving forward

The president more or less said the ECB Monetary Policy Committee cannot be outdone with regards to easy-money policy implementation. We interpreted his comments as a confident gesture that the Euro will continue to weaken against the USD and Pound over the intermediate to long-term.  


European equity performance ugly last week:


  1. Greece led the losers (-9.9%)
  2. Portugal retreated another -6.7% to -17.5% YTD
  3. The German DAX fell -2.2% to -5.7% YTD


Both the quant signals and our GIP model suggest Europe may slow for the next three consecutive quarters which could potentially warrant a surprisingly more dovish ECB policy. CAN DRAGHI CONVINCE THE MARKET HE’LL BE MORE DOVISH FROM HERE? Unfortunately don’t possess a crystal ball, but the recent weakness is concerning…




We DO believe growth estimates for the full year in the U.S. remain too high, and a more dovish tone will likely be received as bullish for gold on the margin. Please feel free to ping us with any comments or questions.





Ben Ryan







Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

Cartoon of the Day: 3% GDP?

Takeaway: 3% GDP in the back half of 2014? That looks almost impossible.

Cartoon of the Day: 3% GDP? - GDP cartoon 08.11.2014

This Chart Illustrates One Reason Why Chipotle $CMG Is Crushing It

Takeaway: Hedgeye restaurants sector head Howard Penney still (really) likes CMG.

Got pricing power?  Chipotle does. 


This Chart Illustrates One Reason Why Chipotle $CMG Is Crushing It - chipotle


Traffic growth has more than doubled price growth over the past 5 years.

Organic Earnings Season

Summary Thoughts

  • “I would say that the competitive activity in this space has been very intense.” –John Foraker, Chief Executive Officer of BNNY
  • “Heavier competitive pressure and that pressure could be branded promotional pressure or some private label expansion.” –Greg Engles, Chief Executive Officer of WWAV
  • The battle in the mac & cheese category continues as both BNNY and WWAV say they are on track.
  • One of the more telling trends we are seeing of late is the shift in the grocery retail space.  As more natural-oriented retailers’ comps have slowed, the same-store sales for conventional grocers have improved.  Clearly, the bigger grocers are doing a better job focusing on natural and organic as a core initiative to try to draw customers into their stores.  In addition, fierce competition among natural chains is driving notable cannibalization.
  • The mix shift to traditional grocers is adding incremental growth, but it’s coming at lower incremental margins.
  • Europe is a bright spot.
  • Inflation pressure remains an issue – dairy, almonds, organic wheat, etc.
  • BDBD and BNNY are both calendar 2H14 margin recovery stories.
  • WWAV said organic growth will decelerate from 11% in 2Q14 to 8-9% in 2H14.


WWAV remains the strongest company in the organic space and is on our Investment Ideas list as a LONG.  We note, however, that organic growth will decelerate sequentially from 11% in 2Q14 to 8-9% in 2H14.


WWAV’s top-line increased 36% in 2Q14 as a result of double-digit organic net sales growth, which was over 11% in the quarter.  Excluding Earthbound (and joint venture-related investments), organic operating income grew more than 2.5x the organic top-line growth rate, with operating margins expanding by over 100 bps.


Sales were up 38% in North America, including up more than 8% on a purely organic basis.  Top-line results were driven by strong growth across all platforms, with plant-based beverages, coffee creamers and premium dairy all producing strong growth rates in 2Q14.  The most recent acquisition, Earthbound Farm, grew by double-digits again in 2Q.


Organic growth guidance: Top-line guidance also includes an organic growth rate that the company expects to be in the 8-9% range in 2H14, with Europe being accretive to overall growth.


Plant-based beverages: Plant-based beverages grew 17%, led by almond milk growth of over 40%.  Almond now represents almost 70% of the total plant-based beverage category.  Silk almond milk continues to be a key driver of this growth, as sales grew by 45% in 2Q14 off an already sizeable base.


WWAV is the plant-based market leader, with Silk holding a 56% share of the total category and holding the number one position in the almond, soy and coconut subcategories.


“All major national branded almond milk players saw share pressures.  We saw a step-up in both private label almond milk distribution expansions at a major retailer, plus we saw continued promotional pressure in the segment.”


WWAV continues to experience exceptional growth in Europe, with the plant-based segment reporting sales growth of 26% (18% on a constant currency basis) in 2Q, consistent with the strong growth it experienced in 1Q.


Horizon: “Our recently launched snacking line platform is performing very well, and as we expected, we experienced heavy competitive activity when we entered the mac & cheese category, but continue to be pleased with our results today.”


Management is confident about the potential of the brand: “The rollout of our new center store Horizon product continues to grow in-line with our expectations.  It will be some time before these brand extensions become material to our results, but we remain encouraged by the strong repeat usage we’re seeing and increased levels of distribution we’re achieving.”


Organic milk grew 8% in the quarter, ahead of expectations, and accelerated from 2H13 when growth was closer to 5-6%.


Organic packaged salads: The organic packaged salads category continues to grow rapidly, up 18% in 2Q14.  WWAV’s share of the total organic packaged salad category increased by 2 points to 24% in the quarter.  Earthbound Farm continues to maintain a leading 55% share in the branded organic packaged salads segment.


Coffee and creamers: The coffee creamers and beverages platform grew 5% in the quarter, as WWAV continues to experience a negative overlap within iced coffee as a result of enhanced competitive pressure in the back half of last year.  The premium dairy platform delivered top-line growth of 8% in 2Q14, despite an approximate 1% drag on asset sales.

BDBD: Strong Organic Growth and Declining Margins

We have a favorable view of BDBD and it remains on the Watch List as a potential LONG.

Total net sales increased 18.7% in 2Q14 as organic net sales increased 19.4%, well ahead of the company’s 13-18% guidance.  Organic growth in the natural segment, which includes EVOL, increased 34.8%.  The gluten-free brands, Udi’s and Glutino, reported strong net sales growth of 26.9%.


Gross margin was 35.7% in the second quarter, a decline of 610 basis points.  This decline was primarily related to the increase in egg white pricing, which negatively impacted gross margin by 210 bps, as well as a mix shift to lower gross margin natural brands.


The company made a number of changes in 2Q that should begin to payoff in 3Q.  We believe the combination of a price increase, formula changes, cost reductions and securing egg whites for the balance of the year will lead to a strong rebound in gross margins in 2H14.


The company also reaffirmed its guidance for the balance of FY14, which includes:

  1. Net sales to be in the range of $540 million to $550 million
  2. Organic net sales growth in the 13% to 18% range, with the Natural segment expected to come in at the high end of the range of 25% to 30%, and Balance to be flat to slightly positive.
  3. Adjusted EBITDA to be in the range of $89 million to $91 million, EBITDA to be in the range of $79 million to $81 million
  4. EPS to be in the range of $0.39 to $0.41 per share, based on 64.1 million shares outstanding.
  5. 3Q14 EPS of $0.10 to $0.12
  6. 4Q14 EPS of $0.18 to $0.20
  7. Gross margin to improve to 41% by year end from an average of 37% in 1H14

BNNY: Strong Organic Growth and Declining Margins

BNNY remains on the Hedgeye Best Ideas list as a short.


Consumer demand for Annie’s products remains very healthy, despite a more competitive environment.  In U.S. grocery, BNNY’s number of distribution points increased 10% year-over-year and its market share was up 100 bps despite seeing increased competition in the mac & cheese category.  Having said that, an increase in trade spending is negatively impacting gross margins.


Consumption increased in the high teens during the quarter, driven by very strong baseline performance in all sales channels and in most categories.  BNNY continues to benefit from driving mainline distribution in conventional grocery stores.  Consumption trends in the natural channel remain very strong, growing at approximately 9% in the quarter.


Organic wheat prices remain at historically high levels, up ~40%.


BNNY’s gross margins continue to be under pressure, due in large part to inflation and increased trade spending.  The company expects to realize a 4% price increase in 2HF15 to improve the margin structure of the company.  Gross margins should approach the mid-thirties during this period.


The company is guiding to strong earnings growth in 2HF15, as they benefit from mid-year pricing actions and productivity gains.  Guidance is for adjusted net sales growth of 18-20% and adjusted diluted EPS of $0.88-0.95; we remain skeptical that this will happen.


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta