RH - Why NSP is NOT An Issue

Takeaway: Punchline = if you’re worried about RH New Store Productivity, don’t be.

We’ve had a barrage of questions over the past 24 hours about Restoration Hardware’s new store productivity – or lack thereof. First off… there is absolutely positively nothing ‘funny’ going on here as it relates to asset productivity. Unlike an apparel retailer that adds four stores per week, RH is adding four this year. It is a different animal altogether, one where the timing of an opening date, revenue recognition, and whether or not a Legacy store is closed all meaningfully impact what people consider ‘New Store Productivity’. Second, this is absolutely positively nothing new. There have been anomalous factors impacting the reported numbers for nine months now. Someone simply decided to write a report yesterday highlighting it 2 weeks after the earnings report.

 

Also, let’s not forget the big picture here. This company just finished a seven-year period where it consistently shrunk its square footage footprint every year, and just started off an inverse period where it will grow square footage by 20-30% annually over another 5-7 years. Given its limited store count, unique customer ordering profile, and radical change in the box size, it’s a near certainty that there will be major swings in ‘new store productivity’.  The good news is that what has hurt RH for the past nine months should start to go the other way later this year.

 

There are 3 factors impacting the numbers, which are as follows:

 

1) Timing of Sq. Ft. Growth – RH grew square footage by 9.6% in the quarter. By standard thinking, that should flow through to the top line. But over the past 4 quarters, we’ve seen sq. ft. growth in the 5%-10% range while the spread between Brand Comps and Consolidate Revenue growth has been flat to negative. We understand why that draws red flags. In the most recent quarter – that is mostly explained by the timing of the new design gallery openings in Melrose (10/24/14) and Atlanta (11/21/14). If we exclude the net new square footage from these two stores, about 50k sq. ft., square footage growth in the quarter would have been flat. With the 16k additional sq. ft. from New York and Greenwich offsetting the lost square footage from the Legacy Store closures in Berkley, West Nyack, and Providence.

RH - Why NSP is NOT An Issue - rh 4 9 chart1 

 

2) Shipping Window – The main reason we need to exclude the additional square footage from Melrose and Atlanta is because of the 8 to 12 week (even longer with the port issues) fulfillment window between the time an order is placed and the time that product arrives in homes. Because RH doesn’t recognize revenue until that order arrives in a consumers home, there has been almost 0 benefit from the additional square footage -- YET. This will change in 1Q and build throughout the year.

3) Legacy Store Closures – The company has been paring back its store portfolio for the better part of 7 years. It is finally to the point where all the ‘bad’ Legacy stores are history. We’ve thought all along that RH would not close as many of its remaining legacy stores from this point forward (which is inconsistent with guidance) as it would likely utilize the real estate in new concepts, and would also serve as a buffer for new Design Galleries, which – while bigger – are still arguably not big enough for the respective markets.

a) To offer up some numbers, RH has 64 markets by our classification, and when we analyze each one (which we did) they all have the spending characteristics on high end household furnishings to support at least a 7,000 sq. ft. Legacy Store. That’s calculated by looking at the 2018 addressable market, assuming 10% market share, and 1,200/sq. ft. in productivity.

b) The way the math works, 22 of the 64 markets could support a store between 25k sq. ft. and 39k sq. ft., 16 could support a store between 40k and 59k sq. ft., and another 22 have the market characteristics that could support upwards of 60k sq. ft (that’s 22 Atlantas). Note: in the chart below each bar represents a market where RH currently opperates. The height of the bar signifies the size of the store each market could support. Blue line is an existing Legacy store, red line is a first gen Design Gallery, and green line is an Atlanta.

RH - Why NSP is NOT An Issue - rh 4 9 chart2

c) The decision to close those markets was calculated – meaning that the company could capture sales lost in a closed market in one of its existing locations or online. Some of those sales are probably lost for good, but the dollars that remain get allocated to either the direct channel or another store which is already in the comp calculation.


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