THE HEDGEYE EDGE
We believe that RH is to the Home Furnishings what Ralph Lauren is to Apparel and what Nike is to Athletic Shoes. That’s a meaningful statement given that RH has only 3% share of a $140 billion relevant market.
There Are Several Points People Are Missing
While some people clearly pick up on some of the more positive aspects to the story, we think people are missing the synergistic affect of the following…
- RH is the only retailer of size that is materially accelerating square footage growth to over 30% -- after seven years of right-sizing (ie shrinking) its store base.
- It is taking up the size of its stores from an average of 8,000 square feet to about 40,000+ for its new stores – and productivity rates on these new assets are headed higher. In the old stores, RH could only show 10% of its assortment, while in the newer format stores, the company is showcasing better than 75%. Consumers can’t (and don’t) buy what they don’t see.
- Our research shows that there are 19 markets where RH does currently not have a presence where it could (and should) add new stores. That’s meaningful off a base of only 80 stores. More importantly, there are 50 stores in the fleet that could be upgraded by more that 30,000 square feet each (ie tripled in size).
- In addition to the real estate play, RH is rolling out new categories that should accelerate its share gain in this Home Furnishing space. Most people have heard about RH Modern (launches in about four weeks), but what they don’t know is the unique infrastructure RH has that allows it to profitably scale with its vendor base to keep product flowing into new categories and classifications consistently.
- Lastly, the margin story here is explosive. Margins are sitting below 10% today, and we think they will be above 16% in 3 years. The key reason is the expense leverage on these new properties – which is live nothing we’ve ever seen (ie pay only 10% more for square footage that’s 300% larger). In addition, the company does not have to proportionately grow its sourcing organization with the growth in its store base OR its category expansion.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
The key risk here is that this story is so explosive and game-changing, which means that it will change rather significantly quarter to quarter. The vision is the same. But the opportunities to get there will change. Not only are we OK with that, but we applaud it. Consumer tastes and shopping patterns are a moving target. And although Home Furnishings is one of the more stable parts of retail, the fact is it will always be volatile. For example, the company planned to enter the Kitchens business 1.5 years ago. That’s still a possibility, but there are a few other businesses that were pulled ahead as more commercial opportunities based on where the dice have landed with consumers.
LONG-TERM (TAIL) (the next 3 years or less)
RH is the preeminent brand in the space, and sets/leads consumer style trends/wants/needs but with very little fashion risk. Importantly, we think that RH is in second inning of a game that ultimately may prove to be a double header. We believe the company will add $3 billion in sales over 3-years and climb to $11 in EPS. The earnings growth and cash flow characteristics to get to that kind of number would support a 30+ multiple. In the end, we’re getting to a stock in excess of $300.