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RH | What Could Go Wrong?

Takeaway: We’re confident in RH across durations. But when asked about the ‘worst that could [realistically] happen’ on Thurs, here’s our answer.

We think that the core long-term call on RH is as clear as ever, as is the catalyst calendar over the next six months. We outlined all of this in our two recent Black Books 1) Road to $300 (Link: CLICK HERE), 2) Home Furnishings Deep Dive (Link: CLICK HERE).We also think that the numbers RH will report on Thursday will be spot-on with the type of model we expect to see from RH going forward (comp 14%, Revenue 18%, EBIT growth 25%, Cash Flow 30%+).

 

But yesterday someone asked us…

Q: “What’s the worst we could hear from RH on Thursday”?

 

Our answer sounded something like this (actually it sounded exactly like this).

A: “We’re not worried about the print. RH has never missed a quarter and it’s not going to start now. This will be one of the lighter quarters of the year, and earnings should STILL grow 25-30%. If there’s any bad news, it will likely come in the 3Q comp guide – with earnings potentially shifting into 4Q. There are some legitimate factors that could cause a lull in the top line, and whether or not they materialize, our bet is that the company invokes them to keep expectations grounded.“  

 

Let’s put ‘light guidance’ into perspective. We think that a worst case comp guide is in the high-single digits (we think less than 30% probability). That would leverage to revenue growth in the low dd, and EBIT/EPS 30%+ (the consensus is at 37%). If the worst case scenario were to happen, we’d have to give the revenue/earnings to the fourth quarter.  In other words, the year really does not change materially. Also keep in mind that there is little upside baked into the guidance in 2H from the new categories which already calls for the underlying growth rate to accelerate by 350bps. It’s also worth noting that the company would have to guide 3Q comps as low as 5% in order for the 2-year trend to turn down. We put less than a 5% chance on that happening.

 

What would cause 3Q guidance be light? There are three meaningful business drivers in 2H that move the needle.

 

1) RH Teen -- launch on September 18, with subsequent mailing of 200-page sourcebook and dedicated space inside future design galleries.

2) RH Modern – launches within a week of RH Teen. This will have a 370-page sourcebook with a simultaneous opening of a stand-alone store on Beverly Blvd

3) Starting Late Sept/Early Oct, Successive Design Gallery Openings In

  • Chicago (62,000 feet in the most elite part of Chicago’s Gold Coast  -- but at a non-elite cost).
  • Denver (another anchor property -- using 53,000 feet of the 90,000 left vacant by Saks at Cherry Creek).
  • Tampa (47,000 feet, which is spot on with what our real estate analysis suggests is appropriate for 10% market share and $1,200/ft).
  • Austin (47,000 feet at The Domain – likely to replace one of the two small-format stores in the area, one is just 4-miles away. That makes sense given that our math suggests that Austin could support 50-60k feet for RH).

 Here’s why timing matters.


1) Delivery, Not Order = $. It will take a six months to build mass awareness for the new concepts, but RH should begin to take customer orders at a level that actually matters within 3-4 weeks of launch. Let’s say $50mm combined for both concepts right off the bat. We’re talking about roughly 8 to 9 points of comp in the quarter, which would be an extremely solid start.  But the problem is that even if the orders are placed for both concepts by October 1, then we need to count forward by at least six weeks for revenue recognition, as customers only pay for product upon final receipt. That puts the sales into mid-November, which is the first month of the fourth quarter.

 

2) Ditto for store openings. Chicago and Denver are likely the only stores to impact square footage count for 3Q, but only around 5% of revenue is ‘cash and carry’, meaning that the consumer walks out with the purchase on the same day. The rest of the revenue builds into the fourth quarter P&L.

 

3) RH Cleared The Deck. In anticipation of its new concepts and stores, RH explicitly noted on the last call and on the recent convert Roadshow that there would be a lull in the summer as it relates to new product. That has, in fact, shown up in the online data that we track for RH, as visits to the site seem to have fallen behind last year for the better part of eight weeks. This week’s reading shows that RH is back on par with last year, and we expect that to head meaningfully higher throughout the third quarter. But again, there’s a good 6-8 week lag between the pick-up in business that we see vs. when RH actually sees it on the P&L.   

RH | What Could Go Wrong? - rh internet traffic

 

 

One other reason why RH might guide lightly. Simply put, because it can. It has never had such a position of strength, yet the shorts are already betting against RH with 25% of the float held short.  It has two major initiatives that are stand-alone multi-year growth platforms, and we wouldn’t be surprised to see another announced by the time the year is done.  Add up the four stores being added this year and we’re looking at about 210k square feet. That alone represents about 25% growth in square footage (and that’s not counting Atlanta). Keep in mind that this company went from over 100 stores pre-recession (and before having a defendable merchandise, real estate strategy, and actual management team) to 67 in the latest quarter as it culled bad locations. Square footage grew on occasion over that period in a given quarter, but has settled in around 850k. Starting in 3Q, we should see square footage growth ramp from a mid-single digit rate in 2Q to a number ~20%, then steadily march towards 35%+ in FY16. Then we’ve got 20%+ square footage growth every year thereafter for at least five years based on our real estate analysis.


W | Wayfair Lightning Rod Black Book

Takeaway: Given the controversy around W, we’re releasing a stand-alone Black Book to stress test the increasingly divergent Bull vs Bear cases

Given the controversy around Wayfair, we’re releasing a stand-alone Black Book on Monday, September 14th to stress test the increasingly divergent Bull vs Bear cases. We’ll host a call and presentation at 1pm ET.

 

As background, we published a 90-page Black Book on the entire Home Furnishings industry last week and included our view that Wayfair probably does not need to exist, and is unlikely to turn a profit -- ever. To say that this view proved to be a lightning rod is probably an understatement, especially given the controversy inherent to the name.

 

As such, we’ve been peeling back the layers of this story, and will release a stand-alone Black Book that scrutinizes every line of the Wayfair financial model.

We’ll detail over TRADE, TREND and TAIL durations where we are coming out on items including the following…

 

1) Market size, by category

2) Revenue capacity and trajectory

3) Customer acquisition costs, customer profitability, and churn

4) Eventual landing place for Gross Margins

5) Operational infrastructure, and capital needed to break even

6) The difference in how this name is being viewed by Retail analysts vs Internet analysts

7) Plus much more…

 

Participating Dialing Instructions

Toll Free:

Toll:

Confirmation Number: 13619412

Materials: CLICK HERE

 


McCullough: To Be Clear, The Market Doesn’t Care What You “Feel”

 

In this brief excerpt from The Macro Show earlier today, Hedgeye CEO Keith McCullough answers a subscriber’s question regarding his current thoughts on the direction of the markets and economy.

 

Subscribe to Real-Time Alerts today for access to this and all other episodes. 

 

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REPLAY | Macau September Presentation

watch the replay our of Macau September Presentation below.

 

Click Here to view the associated slides. 


Cartoon of the Day: To the Rescue?

Cartoon of the Day: To the Rescue? - central bankers cartoon 09.08.2015

Hedgeye CEO Keith McCullough has been trumpeting the growing risk of central bankers "certifiably losing control" for some time now (and how to risk manage your portfolio around this dangerous development.) Here's just one of many recent examples. We encourage you to take a closer look at our suite of products that can help you navigate these treacherous macro waters.


CALL INVITE | GOING LONG UNFI FLASH CALL

We will be hosting a live Flash Call on Friday, September 11th at 11:00am ET.

 

As we stated a few weeks ago in a note, we added UNFI to our LONG bench (NOTE HERE). Now, after doing more work we are very confident in the longevity of this company and as a result are upgrading it to a LONG. UNFI has been battered down this year by ~35% due to significant worries stemming from the loss of the Albertsons contract as well as the competitive landscape.  Although increased competition (KeHE) and the potential of the captive systems are some of the biggest risks, we feel that this loss is an isolated incident and the company should not be penalized to this extent.

 

On August 20th, UNFI pre-announced 4Q15 and FY16 outlook and provided some positive color about the future for UNFI. Management provided positive commentary about the performance in the first two weeks of 1Q16, although only two weeks, it’s a marked sequential improvement and suggests that the core business remains strong.  Following the loss of the Albertsons contract, the notion that UNFI will continue to lose customers is overblown and not very realistic in our minds. UNFI provides a value added proposition (a high level service to retailers), offering a wide variety of over 80,000 products at industry leading prices. The industry is seeing continued growth in natural & organic, specialty, ethnic gourmet and fresh, all of which UNFI offers and can package together to provide retailers great value.

 

Following the disappointing end to FY15 UNFI is in a great position to leverage the strong asset base it has built.  Over the past two years, UNFI has gone through a period of significant investment in capacity to take advantage of the growth in the fresh, natural and organic market place.  With this investment in the past, capex will be declining to more modest levels, about 0.6% - 0.7% of net sales.  As a result, free cash flow is going to start to ramp up significantly and coupled with an underleveraged balance sheet M&A will become a bigger part of the story going forward.

 

The topics we will cover on the call will be:

  • The strong competitive position of UNFI
  • The significant growth opportunity
  • The strong financial position
  • Our estimate of +40% upside in the name

 

CALL DETAILS

Toll Free:

Toll:

Confirmation Number: 13618360

Materials: To be provided approximately 1 hour prior to start time

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


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