RH | Lost in Translation

Takeaway: What should be a victory lap is now an oppty to buy RH on sale. Ultimately, the outsized earnings trajectory will make Longs lots of coin.

Conclusion: This RH quarter is going to draw a Mason Dixon line between the Bulls and the Bears. On one hand, the key factors that the Bulls (including us) need to see were profoundly present – giving us confidence that revenue will double, that we’ll see a 16% operating margin, and $11 in earnings power. In addition, RH beat the quarter, delivered 33% EPS growth in what should be the slowest growth quarter of the year, and it took up 4Q revenue guidance based on what it’s seeing so far this quarter (to 20%+). On the flip side, the Bears got a nice little gift in the form of weaker Gross Margins due to promotional activity, and renewed concerns about management. The reality is that this is a transformational growth story that will change on the margin more often than it doesn’t. Even though the 30% short interest already captures a whole lot of bad news, this print won’t make people cover – and probably validates the pressure the stock came under earlier this week. We’ll respect it for what it is, but based on our confidence in the earnings power at play here, we’d use any weakness as an opportunity to buy. The market combined with noise around the evolution of this story gives you a shot at buying it on the cheap every six months or so. We’re thinking that this is one of those times.

DETAILS

This is a pretty good timeline of how we viewed the RH 3Q print.

4:05pm – Press Release: Solid print. Beats the consensus by $0.02 (4%), and takes UP 4Q revenue by $10mm. It’s pretty tough to find anyone who takes up revenue expectations, most companies would simply keep estimates in-line, and upside in their back pocket.  Overall, total revenue guidance and implied EPS of 20-23%, and 40%, respectively. That comes on the heels of an impressive 33% earnings growth in what is widely viewed to be the lightest revenue quarter of the year.

Stock up 5% after hours as the EPS beat and top line guide trump the fear that people had headed into the print earlier this week.

4:30pm – RH Video: Now we’re feeling really good about this event. The video was targeted, on point, and Gary Friedman appeared to be more focused and grounded than in any other earnings video presentation.  Furthermore, there are basically two things you need to believe to own this story long term. 1) That the large format stores are both working and are scalable, and 2) that RH can successfully scale the brand into new categories and brand-relevant concepts.

Well, both of those were answered, with Atlanta continuing to accelerate from the Nov 2014 launch, and 2) RH Modern blowing the doors off expectations just one month after launch. Consider this, the Beverly RH Modern store is already doing $1,800/foot after just one month. This is unheard of. The store was previously a traditional RH Gallery, and over the course of two years it climbed from about $1,000 to $2,300/foot, making it one of the most productive stores in the entire chain until it moved to Melrose (larger format) a year ago. And yet Modern got all the way up to a $1,800 per sq. ft. run rate in 30 days? That’s surreal.

The bottom line…we were looking to check two major boxes that the long-term story is on track, and both got a major stamp of approval.

5:30pm -- Q&A With Management: Recall the comment above about how focused and grounded Friedman was on the video? Yeah…about that…

This was definitely not Gary’s best Q&A. In fact – let’s keep it real -- it was probably his worst from the perspective of the average investor. Unfortunately, it’s that average investor who is probably driving the incremental demand for the stock.

What happened? Knowing that the market clipped $300mm in equity value out of RH over the past three days due to an otherwise unplanned Friends & Family sale, we think that IR probably went on offense and asked Gary to make a 3-5 minute statement mitigating concern about promotional activity, and keeping people focused on long-term value drivers. Unfortunately he answered the first question in a 14 minute 20 second monologue which included some statements that prompted a $9 reversal in the stock, flat-out scared the market, and even concerned us (until we got clarity on what’s really going on).

These Are Some Soundbytes That Came From The Q&A:  1) “When we look at the data internally, it is the most promotional environment we've seen, meaningfully so.” 2) “You can't ignore someone like Wayfair today. They're doing big volume.” 3) “The last thing you want to do is you want to let yourself get Amazoned by somebody.” 4) “It makes me think, hey, you know, should we be calling Yellen and saying ‘let us tell you what we're seeing’, because, you know, those things, from my point of view — and I don't mean to make anybody panic, but it's important how we look at those.” 5) “RH, you know, ran a big promotion. Got it. We weren't trying to be shy about that, by the way.” 6) “At holiday time, if you've got stores in retail districts or retail malls and there's thousands of people in those malls and you're not doing something to maximize share, then you're a spectator.” 7) “Taking share is important. There's a reason why Amazon launched Black Friday before everybody else in the world, right? There's a reason why we launched the promotion we did last weekend. You know, it was to take share.“

We’re Pretty Darn Sure That The Intended Message Sounded Like This: “We’re exceptionally pumped about the success of our key initiatives, such as the new large-format Design Galleries, RH Teen, and especially RH Modern – all of which set us up for a breakout 2016 (after a breakout 2015). While we’re winning with our core initiatives, it pisses us off quite frankly, to see fringe competitors go so aggressively after market share. Wayfair put up a 130% comp around Black Friday, and though we don’t compete with them directly, I see the promotional activity in the rest of retail, and don’t want to be the loser when the holiday season ends. Our brand and our business is so strong such that I made the call to pull forward a sale from January to be sure that if anyone is gaining share out there, it is RH. The plan is, that the plan will change. That’s who we are, it’s makes us great, and we’re not going to apologize for it. We’ve never felt better about where we are, and where we’re headed.”  

What’s done is done, and the people out there that don’t like Gary now have 14 minutes of ammo. But they’d better hope that will make the stock go down…because the sheer earnings growth story here should make this one of the top performing stocks in Consumer in 2016.