Takeaway: Lots of noise in 4Q, but tremendous set-up into 2015. Still our top idea.
There’s no shortage of moving parts in the RH print. Though the after-hours stock reaction suggests otherwise, we think that the story is squarely on track. Actually, we know it is. We’re making slight changes to our quarterly estimates, but are not making any material changes to our annual numbers, which remain materially above consensus. While the selloff is not much given the 10% run in the weeks leading up to the print, we’d still take advantage of whatever weakness we see tomorrow. Even if the stock closes up on the day, we’d still buy it here. The roadmap as to why we think this will be a $150 stock at the end of the year is outlined below. But like it or not, the real questions that the market wants/needs answered relate to the financial trajectory this year. They key issues are as follows…
ISSUE #1: 2015 Guidance
The Facts: This was RH’s first cut at guidance for the year. RH guided to EPS straddling the $3.00 consensus – with a range of $2.95-$3.10. RH guided to revenue growth of 14-16%, and operating margins up 100-130bps to 10.3%-10.6%.
The Concern: EPS and margins look fine, but that top line looks low. When we do the math – assuming 14.5% weighted average square footage growth for the year, 20-25% e-commerce growth, and 5% growth in outlets, and new store productivity starting the year at 10% and ramping to 60% by year-end, we need to model a comp approaching ZERO in order to justify sales growth of 14-16%. Keeping it real, if this company all of a sudden starts comping zero in its stores – it arguably does not deserve a 30x multiple.
Our Opinion: There are a few moving parts here.
a) 1Q Port Strike Push: First, there is the revenue push of $12mm due to the port strike (which is over). That accounts for about 3.3% of growth shifted from 1Q into 2Q. This is not unexpected, and not a major deal in the grand scheme of things. Other retailers are losing sales outright, while RH is just seeing a delay. We’ll take that.
b) Guidance: RH is still trying to find its groove with giving guidance. Many people forget how new this company really is. Keep in mind that 2014 was really the first year that it even provided structured guidance. The company had some initial communication speedbumps with things like square footage growth and store openings. Also recall that this company has not been smoking expectations as one might expect from a hyper growth brand like RH. The results have been there, but expectations have been high. Now our sense is that it is issuing 2015 guidance at the start of its fiscal year that it does not think it will miss come hell or high water. Friedman said on the call twice that it is conservative. Though we suspect that in conversations with the Street after the call, Karen Boone will reiterate something that sounds like “Our guidance is our guidance. It’s where we think we’ll come in.” We’re ok with that. If you’re going to be conservative with a guide, you need to be convincing in sticking to it. That might hurt the stock near-term, but it presents a great opportunity.
c) Comp Trajectory Math: Think about the comp like this. RH put up a store comp of 12% in 2014, but that number accelerated throughout the year and ended up at 14% in 4Q. If we keep the 2-year run-rate of 15.6% flat into 2015, we get to an implied comp of 20%. We’re modeling 10%, which puts us 2 pennies (10%) ahead of consensus.
d) 2Q should be a big one. It benefits from…
e) New Store Productivity Ramp: We’re looking for New Store Productivity to ramp from 10% in 1Q to 60% by 4Q. A couple of key points.
f) New Concepts: Management noted two new concepts in the back half of the year.
ISSUE #2: Square Footage Growth
The Facts/Concern: Management talked down ‘low 30s’ to 27% square footage for this coming year.
New York – Flat Iron
HERE’S OUR NOTE FROM EARLIER THIS WEEK, WHICH WE STILL STAND BEHIND
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.
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.
Key Details On The Quarter
Revenue/Comps - For the quarter we are at 21% revenue growth. That’s broken into a few parts, full details below.
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.
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.
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.
Takeaway: Mgmt believes the Macau govt have about 400 new tables to allocate to Cotai in 2015. Mgmt will also ask for additional tables this year.
PRESENTATION SLIDES HERE
Q & A
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Takeaway: By the time utilization declines amid peak equipment deliveries and weak traffic, it may be too late to exit/short WAB, if we are correct.
In our WAB black book, we suggest that US freight rail volumes should weaken and lead to rail capital spending declines into 2016. A decline in US freight rail capital spending (orders, not sales) would be a serious negative for WAB, as WAB shares are priced for continued secular earnings growth. Recent data suggests that this thesis is, perhaps, playing out. In the last few weeks, the shares US railroads have underperformed as rail data has softened. We expect weaker volumes to negatively impact the shares of equipment suppliers over time.
G&W, KSU Guidance Cuts
“G&W’s traffic in the first quarter of 2015 has been weaker than the Company’s expectations due to severe winter weather in four of G&W’s North American regions, as well as weakness in certain commodity groups, including steam coal and metals. Based on first quarter results to date, G&W expects total revenues in the first quarter to be approximately $375 million, or $25 million below its guidance of $400 million provided on February 10, 2015. In addition, G&W expects costs to be approximately $5 million higher as a result of the extreme winter conditions. As a result of these factors, G&W expects net income in the first quarter of 2015 to be approximately $10 million below guidance.”
- GWR Press Release
While Crude by Rail has received some attention, the G&W guidance cut also notes weakness in steam coal and metals. With the approach of the Mercury Air Toxics implementation, coal volumes seem likely to weaken further. Industrial metals prices are also not encouraging. KSU also lowered its outlook on March 23rd, and specifically mentioned lower expenses as an offset to a weaker environment.
Here is what Cass has to say on mode shifting back to trucks:
After a few surges in output, coal production is down again. SCOTUS is unlikely to rule on MATS regulations until well after its mid-April implementation.
Crude By Rail
Lower crude oil prices have not had a positive impact on the growth in crude by rail shipments.
Hard To See Growth in 2015
While some categories, like Chemicals, continue to expand, it is challenging for us to see rail growth in the current environment. By the time utilization has declined amid peak equipment deliveries and stagnant traffic, it will be too late to exit/short WAB, assuming we are correct.