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RH – Key Issues Into (And Out Of) The Qtr

Takeaway: Here's all the numbers we care about into the print -- and why we still think it a very big, very under appreciated idea.

CONCLUSION

Here are the key financial metrics we’re looking for into (and out of) the RH print. The quarter was already preannounced, so the announcement is all about guidance. As we’ve already stated, we think that there will likely be a revenue push from 1Q into 2Q associated with slower deliveries due to the port strike in the quarter. Unlike other retailers that will lose revenue forever, with RH it is simply delayed. Even if this does not actually materialize over the course of the quarter, RH is likely to guide conservatively – a) to play it safe, and b) because it can (other retailers did, and the market is expecting it).

 

In the end, RH remains our top idea in retail. People are finally starting to appreciate the square footage growth story – growing today for the first time in seven years. But we don’t think that they appreciate why. Yes, larger stores a) stimulate greater spending in new categories and b) allow RH to showcase product that previously was shown to consumers in an iPad look-book or a Source Book (physical catalogue). But the story is so much biggger than that. The fact of the matter is that RH is rapidly consolidating the high end home furnishings space not unlike what Ralph Lauren did to the high-end apparel space in 1990 – and virtually all of its competition is structurally unable to compete. On top of that, we think that people are really missing out on the Gross Margin upside in the model as the company halves its occupancy rate (from 12% to 6% of revenue in Denver, for example) as it rolls out its new stores.

 

In the end, we have earnings growing at a CAGR of 45% over the next three years. If our model is right, then the current 30x p/e – which most people tell us is too expensive – will turn out to look downright cheap. And unlike other fashion-driven retail stories (i.e. current concerns about KORS) – you never really have to worry about this business going out of style.

 

When all is said and done, by the end of this year, we think that people will be looking at $5.00 in earnings in 2016 – that’s 30% above the Street’s $3.84. If we assume no multiple expansion (despite the higher earnings CAGR) then we’re looking at a stock price of $150 in a year. A year after that over $200 ($7+ * 30x). The biggest problem we think people will have is modeling the dilution of the convertible debt when the stock breaks $190.

 

RH – Key Issues Into (And Out Of) The Qtr - rh financials

 

Key Details On The Quarter

 

Sales

 

1Q

Revenue/Comps - For the quarter we are at 21% revenue growth. That’s broken into a few parts, full details below.

  • Average sq. ft. growth of 10%, with no new openings scheduled for 1Q15.
  • New store productivity of 10%. We should start to see sales flow in from the newly opened stores in LA and Atlanta but given the timing of the openings in late 3Q14 and early 4Q14 respectively and the extended fulfillment window (8-10 weeks +) we should see that accelerate beginning in the 2nd quarter.
  • Retail store comp of 10%.
  • Direct revenue comp of 30%. Overall we like what we’ve seen out of the visitation statistics from rh.com. The chart below looks at the YY % change in traffic rank which takes into account both unique visitation and page visits per user and ranks each site relative to every other site on the internet. It doesn’t translate to an exact comp number, but directionally it’s a very good indicator as to how things are trending. We expect the new source books/product to be released in early to mid-April, which should lead to a reacceleration of the visitation metric.

RH – Key Issues Into (And Out Of) The Qtr - rh traffic

  • That translates to a 21% combined brand comp. Down 400bps sequentially on a 2yr basis. Port issues could cause some revenue to be moved from 1Q into 2Q, but against weather impaired compares LY we like the set-up in the first quarter on the top line.

Port Disruptions: Our sense is that we will hear a little bit about the West Coast Port disruptions on the call. But, keep in mind that 95% of RH’s business is fulfilled from a DC, or put another way, only 5% is cash and carry (our estimate). Unlike WSM, and just about every other retailer on the planet RH doesn’t need product in its stores to conduct a sale. Could it push dollars from 1Q into 2Q? Of course – and it’s a strong possibility, but unlike WSM and apparel/general merchandise retailers, it’s far less likely those sales will be lost forever.

Outdoor – One of the big whiffs last year in the 2nd quarter was the company’s packaging of its Outdoor Source Book into the 3,200 page bundle that arrived in homes in June and July. The big problem with that is that consumers don’t buy Outdoor furniture in June, they’re sitting in it. The category refresh was unveiled on 3/13/2015, a month earlier than last year when it hit the internet on 4/10/2014 last year. The new collection is not in stores currently, but the e-comm presence should provide an extra boost in 1Q & 2Q this year. Management hasn’t articulated how it plans on handling it’s Source Book strategy this year, but our sense is that we will see 3 or 4 targeted mailings this year delivered at content appropriate times instead of a 17-pound shrink wrapped package that is 6x larger than the average phone book.

 

Full Year
There are still a lot of moving parts on the comp line heading into 2015. Here is a quick look at when the 4 newest Design Gallery’s/remodels will be entering the comp base. We don’t expect any additional Legacy Store closures outside of those closed when RH opens new Full Line Design Galleries in Chicago, Denver, Tampa, and Austin.

  • Greenwich, July 2015 (tail-end of 2Q15)
  • NYC Flat Iron, August 2015 (beginning of 3Q15)
  • Melrose Ave., December 2015 (middle of 4Q15)
  • Atlanta, February 2016 (late 4Q15, early 1Q16)

For the year we are at 27% revenue growth. That’s driven by 14% growth in average sq. ft., a 17% retail comp, 27% growth in DTC, which equals a 23% combined brand comp. We are modeling a sequential improvement throughout the year on a 2yr basis with the highest comp YY falling in 2Q as the company laps the Source Book hiccups in 2014.

 

Margins 

1Q

  • Gross Margin - On the occupancy front the company is facing similar headwinds to start the year as it did in the 1st quarter LY. Additional details...
  • DC occupancy headwinds due to the opening of the new West Coast DC are similar to what we saw when the company dealt with the added cost of the Dallas DC and Ohio Shelf Facility last year.
  • Dead rent started to hit the P&L in 4Q and will continue to be a headwind until the company gets the 4 new doors planned for 2015 fully operational. It takes RH on average 6 months to turn a property once it gets the keys from the landlord. RH opened 4 stores in 2014 so the incremental cost in ’15 should be very slight on YY basis. The only difference here is the Beverly Boulevard store which is currently sitting dark while the landlord collects rent.
  • On the positive side, the company will see a benefit on the merch margin side as the price increases associated with the 2014 Source Book launch flow into the 1st quarter.
  • SG&A – The change in source book strategy will be a headwind in 1Q similar to the prior two quarters. On the positive side, there are no incremental costs associated with new store openings. Net/net we think it’s a positive. We’re modeling 45bps of leverage in the quarter.
  • EBIT Margin – For the quarter we are modeling operating margins at 5.3%, driven by 100bps of GM improvement and 45bps from SG&A leverage. 

Full Year

  • For the full year we are modeling 210 bps of EBIT margin improvement from 9.2% this year.
  • Gross Margin – The 70bps of GM improvement in 2015 is driven by a) occupancy leverage as the new Full Line Design Galleries start to make a meaningful impression on the top line and b) the once per year Source Book strategy continues to smooth out the product flow curve helping on the shipping side. We don’t expect a big benefit from mix (as in a larger percentage of non-furniture business) until some of these new categories hit critical mass and kitchens fully ramps up. That will be a 2016 event. Dead rent and DC occupancy will be a headwind for most of the year.
  • SG&A – Leverage on this line item should improve sequentially throughout the year as the company laps the increased marketing spend from last year driven by the 17lb Source Book. That coupled with G&A leverage on higher sales volume gets us 140bps of leverage for the year.

GS: Adding Goldman Sachs to Investing Ideas

Takeaway: We are adding GS to Investing Ideas.

Editor's Note: Below is a brief note written earlier today by Hedgeye CEO Keith McCullough. Our Financials analyst Jonathan Casteleyn will provide a deeper update this weekend.

GS: Adding Goldman Sachs to Investing Ideas - 45

 

I still don't like the Financials (XLF) so I get why they are down -2% YTD (vs TLT +5.5%). But I also get that there is a time to cover shorts when they are signaling immediate-term TRADE oversold. 

 

Instead of buying the ETF, we'll opt for 3% of it, Goldman Sachs (GS), which continues to signal bullish on both our intermediate-term TREND duration and research.

 

Long-term, Jonathan Casteleyn likes Goldman Sachs, but in the short-term, he sees the upcoming GS quarter as follows:

 

The Q1 period is seasonally the best for FICC and intra-quarter commentary at several investment conferences lends confidence to a much better sequential print for fixed income trading from an abnormally low 4Q14 result.

 

GS Asset Management is also taking share and will contribute to an improved upcoming quarterly result. 

 

Buy on red.

KM



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LEISURE LETTER (03/26/2015)

TICKERS: SGMS, CCL

 

EVENTS

  • March 26: Macau Legend 4Q conf call 8:30-9:30pm (EST)
  • March 27: CCL F1Q, 10am -

COMPANY NEWS  

SGMS - currently holds the West Virginia contract to provide the central monitoring system. That six-year, $6.2 million was originally awarded in 2006 and was extended when the six-year term expired. The current contract is set to expire in 2017.

 

WV Lottery director John Musgrave said the Lottery would like to have the bidding process complete a year before the current contract expires to allow for any transition period that might be needed should a different vendor win the contract.

 

Meanwhile, the state’s various lottery games generated nearly $94.7 million in revenue in February, about $2.2 million better than the $92.5 million forecast for the month. However, it was about $4.2 million less than the $98.9 million generated in February 2014. Better than expected revenue from video lottery games at the state’s four racetrack casinos, along with a boost in online games thanks to the $564.1 million Powerball jackpot during the month, helped offset a sluggish performance in limited video lottery revenue during the month.

 

Musgrave said the casinos are seeing a slight increase in consumer spending. He hoped that the improving spring weather combined with improvements in the regional economy will have positive effect on casino revenue in the next few months. “We would like to think we’re seeing an increase in disposable income,” he said.

ARTICLE HERE

Takeaway: Can SGMS hold on to the WV contract? In addition, WV casino revenues haven't seen a growth month since June 2012 due to stifling new competition. The decline will continue in March.

 

CCL - Carnival is ready to order 10 new ships and to sign a construction contract with the two biggest shipyards in Europe, Fincantieri in Italy and the German giant Meyer Werft. 

 

The announcement with the details of the ships, the shipyards involved and the total figure for the agreement are expected by the end of this week, perhaps by Friday. The commission from the American company will be divided equally between Fincantieri and Meyer Werft.

 

The market price for these units would be between $700 and $800 million each, a figure that would bring the total value of the commission for Fincantieri to $4 billion. Other sources confirm that the order, when announced, should include a new class of ship for the Costa Cruise fleet: a 170,000-tonne prototype that could be ordered with a twin ship.

 

The other ships should be divided between the American giant’s various brands, Carnival in particular urgently needing a renewal of its fleet. New ships for Aida are also at stake: the group’s German brand, after the complicated construction of its latest ship in Japan, the “AidaPrima”, Aida decided to build its next ships in Europe. 

ARTICLE HERE

Takeaway: Build it and they will come.... CCL hopes that is the case.

 

CY Foundation - CY Foundation Group Ltd, the parent of Macau-based casino services provider CY Management Ltd, said its plans to expand slot machine operations have to be extended beyond the original deadlines.

 

“Given the recent changes in market environment in Macau, the group has not been able to achieve its target to expand the number of gaming machines in operation to 1,000 by the end of this financial year [on March 31, 2015],” the company said in a filing this week.

 

CY Foundation identified the market changes affecting Macau’s gaming industry as “the enforcement of non-smoking policy in casinos, mainland China’s policies on restricting frequency of visitation to Macau and the anti-corruption drive within mainland China”.

 

The company had said in its interim report in December that its goal was to expand the number of gaming machines in operation to 1,000 by the end of the current financial year, and to 3,000 by the end of the financial year ending March 31, 2017.

 

CY Foundation said it would continue to explore potential sites in Macau and Southeast Asia.

ARTICLE HERE

 

Japanese pachinko operator Niraku Holdings is IPOing in Hong Kong to raise US$49.5 million.

Niraku is selling 30 million shares at HK$1 to HK$1.28 each in the IPO, which closes Friday, Macau Business reported.

The money will be used to build five pachinko halls in northeastern Japan.

The $49.5 million is significantly less than the $100 million to $200 million Niraku originally expected to raise.

Niraku is one of four pachinko operators expected to go public this year.

 

 

INDUSTRY NEWS

 

C

MACRO

Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.


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