Let’s start with the bear case. RH just missed top line on what was what I’ll call a ‘confidently bullish’ revenue forecast coming out of last quarter – and it missed in an environment when every junk-tailer on the planet is crushing the top line (even if by accident). There’s almost no way the stock goes up on an announcement like that – regardless of such a huge earnings beat.
NEWSFLASH: I don’t care.
Here’s why…
Let’s look at what this company just did. It comped 5% -- consciously (it could have comped 15% if it wanted to) – while driving $59mm in incremental gross profit on $24mm in incremental revenue. Have fun sticking that one in your bear cap. Have just as much fun finding any other company in any industry that is flowing through that degree of incremental return on invested capital – especially one with more square footage growth than 99% of publicly traded retail.
If you haven’t figured it out by now, this is not a company or a model that is even remotely predictable on a quarter to quarter basis. If you think you can play the comp game quarter to quarter on this company, then you’re sorely mistaken. This isn’t Kohl’s or American Eagle. Invest there if you want – but please don’t (unless you can short). RH has beat EPS in 21 out of the last 24 quarters – it beat comp maybe 10 times. I’m ok with that. Comp volatility is not new territory for RH and the market knows it. Or it should, at least.
I’m not here to say that ‘quarters don’t matter’. Gary Friedman mentioned on the call that it is not a Q to Q game. I humbly disagree. They do matter. Quarters add up to years. I like years. This scrutiny is the cost of being a public company. It’s something I’ve learned to live with being a long term bull on this business model.
But I’d take it a step further – this is not a Q to Q model. It is Day to Day. RH’s plan, is that the plan changes – every day (the company might not articulate this way, but I will). This is Retail folks…it’s a full contact sport, and if the plan does not change as new opportunities and challenges present themselves every minute of every day, then it’s a great recipe to lose. And over the long term, RH will not lose. The team has no problem ‘disappointing’ on key line items to do what is best for the company, the brand, and most importantly, anyone invested in this name with the intent of creating meaningfully outsized long term value.
All that said, I think that this is an end of an era (and not just bc we’re saying goodbye to CFO Karen Boone – which is one of the few risks that concerns me). We lived through the supply chain mis-steps which, among other things, drove this stock from $105 down to $26. Then the CEO buying back nearly half of the float at the bottom in what will likely prove to be one of the best financial engineering moves any of us will see by a public company in our careers. Slap that financial leverage on top of an operational turnaround, and there’s EPS going from $1.27 to over $7 over the course of 3-years and the stock being up 225% over 12 months. Era over…now there’s a new baseline from which to grow.
About three years ago, the fundamental call here mattered. The white space mattered. The asymmetric share gain mattered. The new store productivity model on a reimagined approach to retail mattered. Then it got lost in the volatility of the past two years. Now these things matter again, and they’re worth something – something big.
As RH executes on a carefully and deliberately slower square footage growth model of 15% annually while layering on new businesses – not the least of which is RH Color, which I think is its biggest opportunity launched to date – we’re looking at new galleries driving comp comfortably in the 5% range. That’s aggregate ORGANIC top line growth of 10-12%. I think that a mid-teens margin target is aggressive, but can RH touch 13% and stay there while sustaining growth? I think the answer is yes. 14% is within reason. The recent convertible once again de-risked the balance sheet to the point where we have to worry about convertible dilution instead of default (big difference), and RH likely to refi interim-maturity debt. In other words, even in the case of a recession, I’m not concerned about the balance sheet especially in light of how creatively it is striking new real estate deals with limited capital outlay.
Ultimately, this is a company with an organic 20% earnings CAGR from here – and it’s only competition is itself. Furthermore there are fewer than 10 retailers in the world with quality square footage growth opportunities. RH is in the top three. Will we see volatility in the back half of this year? I hope so. Because without it, it’d suggest to me that the company is becoming less nimble and losing its edge and willingness to change -- fast. This kind of story is not for everyone. But with internally funded $12 in EPS power over a TAIL duration, the stock looks cheap to me at $150. 20x $12 = 240. That’s when I consider this name fairly valued – until the plan changes – which it will. And I welcome it.
--McGough
