When you’re crushing your business plan, the piano overdub on the earnings video sounds pretty cool. But when it’s your second meaningful guide-down in two quarters, it sounds kind of like a funeral.
That’s especially the case in that there’s very little in this release that we’d consider new. The boom was lowered last quarter when problems with Modern, Energy/FX markets, and Promo Cadence change/Grey Card introduction sent the stock from $80 to $35 over four torturous months.
Are there any new issues hurting numbers? Not really. Same items. Knowing nothing else we’d say that the issues at the start of the year were entirely operational in nature. While this time around, its more about the forecast accuracy related to those issues. (i.e. this is one big ‘event’ but the quarters are split between ops and finance).
When we point to forecast accuracy, however, we have to first look in the mirror. At the end of last year, we were carrying a 2016 estimate of $4.50, and yet it appears that RH will come in less than half of that. To be clear, we move our numbers when our research says to, not when a management team says so. I’m taking flack here and I deserve it.
All of that said, we’ve all seen analysts pull the plug on a stock at the bottom – sometimes because their mandate requires them to downgrade on a miss, sometimes because their credibility is blown, or they simply lose confidence.
As it relates to RH, I have round-tripped this sucker – from $29 to $105 and back again. Do I think about bailing everytime the stock blows up? Yes – for a moment. But the truth is that none of the mayhem – and it IS mayhem – affects the earnings power that our research suggests will be near $8.00+ in 5 years. With the stock at $100, people hardly questioned our logic. Now they snicker. “You’re telling me that this is trading at 3x earnings?” Yes. I am.
But duration matters. It always does. We’ve been saying since the end of February that we’d buy the stock all day – but only if you can look nine months out or more due to 2016 uncertainty. We still think that’s the case.
The Triple Standard
It’s funny…with companies like Lululemon and UnderArmour I so often say that a Great Brand ≠ a Great Company ≠ a Great Stock. The biggest mistake I’ve made with RH is missing the fact that the company is simply not as great as the Brand. The company is far younger (8 years) than the brand (37 years). That gap will never go away. But over the next year we think that RH Inc. will go from being a sub-par company – appropriate for the sales base when it went public – to a great organization that will drive one of the premier brands in retail, and fuel what we think will prove to be a financial model in the top 2% of Retail.
Think about it, would you rather this be a company like Wolverine Worldwide – a great company with mediocre brands (and a permanently low valuation)? That’s pretty hard, if not impossible to fix. With RH, we’ll see this company fixed in a year’s time, and results exceeding expectations well before then.
We’ll be back with more details.
Below is our previous note on RH from this morning:
RH | Then and Now and Tonight
We have an upside bias to tonight’s print. But at this valuation, the market thinks RH is broken across any duration.
We’re roughly in-line on both comp (+5%) and EPS (+$0.06) for RH this quarter. Our bias is to the upside on both metrics, but we think there are other things that matter a lot more. Let’s face it, this is a seasonally weak quarter for a company in the midst of a well-telegraphed yet painful transition period. The way the stock is trading, the market thinks that virtually no part of our long term bullish view is going to happen. On our numbers, RH is trading at less than 8.0x earnings, and at 4.0x EBITDA – and that’s on NEXT YEAR’s numbers – it’s not like we’re telling you to look out to 2018 or ’19. So clearly, the market simply lost massive faith in this story and in the management team’s ability to deliver. We have not. Are we worried about the back half? Yes, particularly as the switch to the new promotional cadence (Grey Card ‘club’ as opposed to ‘in your face’ episodic promos) takes place. Most people generally get the revenue volatility that’s likely coming down the pike. But very very few people we talk to actually want to take the plunge and own it through this year. And there you have a 4.0x EBITDA multiple.
Also consider the following comparison of RH today to RH on its IPO. The table below tells it all, but here are some callouts. Enterprise Value is now a mere 14.5% higher, and yet…
1) Revenue has doubled to $2.1bn
2) Margins have more than doubled to 9.7%
3) Productivity went up by over $1,000 per foot, which is simply an astonishing statistic.
4) Net Debt/Total Cap went from 38% to 5%
5) P/E went from 30x to 13x
And keep in mind that at the time of the IPO, the ‘growth’ was in 20k foot Design Galleries, but we’ve since learned that landlords are giving RH preferential terms on 40k-60k sq ft properties, and they’re working as it relates to gaining outsized share of each of those markets.
Our point here is that the valuation has been decimated over this time period, and yet the growth story has expanded if anything, and been de-risked from a funding perspective. Is it in a pretty ugly pivot period right now? Yes. Might the company need to invest more capital to facilitate growth? Perhaps – worst case. But for a long term investor (ie you can look out 9 months or more), this name is as appealing as they come.