Our Positioning (McGough)
The fact that RH beat the quarter by 22% and beat comp expectations by 700bps is irrelevant given the fourth quarter guide. It’s easy for me to say that management knows it is in deep trouble from a credibility perspective and that it is guiding such that it won’t miss another quarter. But I won’t say that, because I’d be wrong. Let’s be real, this is more than just a sandbag. It is the inability of a management team to execute. Period.
- Does it matter that it is poor execution by the team that was in place on Jan 1 instead of the very different team in place on Dec 1? No.
- Does it matter that the stock ran up by 40% in the five weeks leading up to the print? Not a chance.
- Does it matter that the compares on the earnings algorithm get easy starting next quarter, at a time when the sales/inventory trajectory is finally aligning? Nope.
- Does the TAIL call $5, $6+ in EPS power matter? No way… This like AMZN, the TAIL call is great. But we gotta get through the near-term first (though AMZN is peak sentiment, RH is trough. AND people actually believe the AMZN TAIL, unlike RH).
- This stuff (especially the TAIL call) is useless today, and I don’t argue otherwise one iota. People will see what’s right in front of them. And what the company is presenting to investors today smells like a rotting carcass.
Let me be clear about three things.
1. This has been both the best and worst call of my career. On it at $29, and failed to get off it at $105. #RoundTripsSuck. But let’s get past the pity party -- fast. There’s real money at stake.
2. I am absolutely not married to this call. If I did not believe that there is real money to be made here, I’d drop it like an M80 with a sparked fuse. But I’m sticking with it. Here’s why…
3. There is one reason – and only one – why I am sticking with this call (and it is not to simply stay out of consensus for the sake of being there – that’s not my bag). It is because this is one of the only companies I can find that is INVESTING while the business is pressured. Consider this…
a) RH started the year with RH Modern. A great idea, but mis-executed. That does not make it a bad idea. Just costly up front.
b) At the same time, RH abandoned its promotional model. No more ‘40% off’ emails blanketing people’s inboxes. Simply put, it made the selling cycle and promotional activity more consistent with the higher end brand that it is.
c) It finally re-set it’s ‘Core’ product this year (in the fall) for the first time in about four years. This distracted the ‘team’ further.
d) It opened 4 stores, or 165k square feet during the year. The greatest square footage addition in RH history. This alone accounted for 22% growth in square footage for RH vs this time last year.
e) All of this happened while category growth went from high-singles to near-flat, and the likes of WSM, W, ETH, HVT and BBBY all imploded. Horrible timing at face value, though the way I see it, you want to invest when others cower in the corner. That’s how you win the game.
I use the word TEAM up above loosely. Because at this time last year, this was pretty much ‘The Gary Show’. That’s what we’re seeing today in numbers. But that’s not who’s sitting in the C-suite today. We’ve seen the addition of a new merchandising organization and a new supply chain team, as well as a clear delineation of duties and reporting structure at the company. Simply put, this was a toddler management team seeing the company through puberty. Now there are adults in the room to collectively steer the ship and execute on the plan.
I could say this til I’m blue in the face, and it won’t matter one bit. The fact is that what we’re seeing today matters…until it won’t.
The irony is that I meet with so many investors (four this week in London) that say “I like to find great brands at trough margins and depressed multiples.” But when push comes to shove, people usually balk, if not flat-out look the other way. I don’t blame them. It’s ‘scary as all get-out.’ But this is the result of mis-executing on too many very good ideas, not simply sitting idle while the will of the consumer drifts away from the Brand (like so many others are doing). No way will the company get a pass – nor will I suggest it deserves one. But consider these facts…
- KSS put up traffic -6%, and beat solely due to pulling SG&A down by 1.7%. CFO is leaving. Underinvesting. Massive credit risk + aggressive lease arrangements = less than $1 in core earnings vs $4.00 today. Stock rallies 39% after the print.
- TGT put up a weaker than expected comp, eroding profit algorithm, unsustainable SG&A cuts, and ‘pie on the sky’ guidance for 2017, and the stock is up 17% since the print.
- RH comps beat on the margin (though still down), takes UP SG&A by 10% over last year (investing), Capex +26% yy, and continues to invest in vendors with Days Payable down by 25 days vs last year – a temporary (yet critical) investment.
If this were the management team of 1-2 years ago, I might discount these investments on the P&L (which are not being stripped out as ‘special charges’) as potentially having a negative return in perpetuity.
But it is a different team today, a ‘real team’ for once, and one from which people will only see its fruits in another 2 quarters.
Major Retail Set-Up for 2017 | Winners Should Finally Win
In totality, we’re faced with a textbook trend today where bad ‘brands’ are pulling capital out of the model and are being rewarded, while solid brands/IP are investing (albeit sloppily) and are getting clocked. I am not so disillusioned as to think that my banter can turn opinions around. But my very strong sense is that we see a real bifurcation in earnings in 2017 in Retail. The sins of 2015/16 will come back to haunt the weaker brands/retailers that are behaving badly (HBI, KSS, TGT, TIF, FL, HIBB, FINL, CRI, JCP, etc…). Lower margins, weaker turns = severe multiple compression on lower numbers. On the flip side, those that are investing in the face of top line pressures (RH, NKE, RL, DKS and WMT) will accelerate market share gains, accelerate top line, improve margins, while simultaneously improving operating asset turns. That = higher ROIC and multiples on earnings beats.
While on the road for the past two weeks, the sentiment I’m getting is “2017 matters a lot, just not today. I have to get past December and 4Q before I can focus on ‘17”. My sense, actually, is that many buy-side analysts aren’t allowed to care about 2017 yet. That’s fine. But something we should keep in mind as it relates to our process and approach to the new year.
I get it that it won’t matter til it matters. But the time-line over which RH plays out should be measured in quarters, not years. If your boss lets you care about 2017, you’re at a clear advantage in the Retail space, and likely elsewhere (and on many names, not just RH). This is a time when I’m willing to go out on a limb and make bold and unpopular calls – as painful as it might be on a given trading day. The research supports it, and more often than not – the right research ultimately wins.
Brian McGough
