There’s not much I can say that a 7,194 word press release can’t. But it’s fair to say that I’m the biggest RH bull on the Street. I had a $300 target on it when the stock was at $26 – and looked (and felt) like a moron when it sold off in 2017 and I was still saying that it had $12 in EPS power. But the math said to go big. Now the company is out with numbers and guidance that literally knocked even my socks off. If you’re not looking at $12 in EPS power two years out – you’re not doing the right math. Buying the stock on that sell off was buying it at 2x earnings. And that’s exactly what Gary Friedman did in what might be the best-timed financial engineering move/bet I have ever seen in my career. Pardon me if this comes off as a pat on my own back – bc in full transparency I was flat out wrong/stupid (miserably so) for a good nine months. But even after 25-years in the business this is a great case study for me personally that when you have the fundamental research call nailed and well-placed faith in the people executing the story – you gotta stick to your guns even when the market tells you that you’re wrong.
BUT then you have to be sure you don’t fall in love with yourself, put on the big boy pants, and apply a proven analytical process to predict and accurately forecast what comes next. That’s where we are today. You’re only as good as your last call in this business…and there’s still a call to be made here. Yes, it’s a very bullish one.
Now we’re sitting here with the stock trading near $150 after hours, and the clear question people will be asking is whether we just saw the best RH has to offer – whether the beats will slow (newsflash – they will) – when the earnings growth will taper – and when the company will experience another gaffe (or series of) that takes $500mm-$1bn in market cap out of the equation in a painful selloff -- just because that’s what RH stock sometimes does. I think those are all fair questions – especially the latter one. This is a company where the story changes every day. That’s why it’s a winner. That’s why you can’t hold the company to a long-term target every single quarter. Every once and again you’ll get a fat lip until you’re rewarded 3x over a year down the road. If it stuck to the same playbook day in and day out then legitimate business opportunities would fly by and end up unrealized and in the hands of punk competition. Then WSM might actually might be a long (not). RH won’t catch ‘em all. It’ll reach. It’ll occasionally fail. And I’m ok with that. But like any championship team, it wins when it counts. And by the way, that whole ‘when will RH mess up next?” question matters at $250, not $150.
So that leads me to the big question – which is where should RH be trading at today and more importantly over a TAIL (1-3 year) duration? I’d say that we should just let the market decide that. But let’s face facts…the market has mis-valued this stock more times in its public history than I can count, which has presented amazing opportunities on both sides. But let’s get off the treadmill for a minute where we talk about incremental comp, NSP, gross margins, and inventories…and all the simple metrics that even high quality retailers and brands harp on every quarter. This is different. This is transformational. It’s been there. It’s been building. But now it’s finally apparent. There’s nothing like this that exists in the world of Consumer Discretionary. I have my analyst right now running screens on what companies in any business from e-comm, to financials, to luxury goods, to biotech that have ROIC of 40-50% and are growing EPS better than 30% (or over 175% in the case of 2018). Newsflash: RH is in the top decile of ROIC, and bottom decile of valuation in retail.
- The closest one in retail to where RH is today is ROST at 42%, and that business is hardly as defendable as RH (trades at 13x EBITDA this year – still 30% better than RH) – with stiffer competition and slower growth in a mediocre category.
- The list of other high-return concepts is slim, and those that make the cut trade at ‘cult-stock’ valuations of 30x+ EBITDA.
- Seriously, I just separately wrote a comment on FIVE (26% ROIC) and OLLI (15%) – two companies that shouldn’t be mentioned in the same sentence as RH – and they’re trading at 26x EBITDA without anywhere near the defendability of concept – or the growth or return profile.
- Kering is at 11% ROIC… LVMH is 16%. And even though these lux stocks are washed out they’re still more expensive than RH.
- Apple’s ROIC is 27.5% -- lower than where RH will end up this year – in a more penetrated and consolidated space with stiffer competition. Am I actually saying that RH deserves a bigger multiple than Apple? Yes…you’re damn straight I am. It also deserves a MUCH higher discount rate due to the quarter to quarter risk profile, but if you invest on a TAIL duration, the trajectory here is simply better.
That’s about as far as I’ll go in arguing a multiple. I’ve found that a multiple expansion call is usually a pretty lousy one. This is all about execution on an extremely well-thought-out plan, and outsized earnings and cash flow delivery. If there’s any caution I have it’s that the LAST thing you can do is take the RH targets and straight-line ‘em. At this point, the company only has really one hurdle – which is falling in love with itself. Same challenge that someone faces who was right on the stock this quarter/year. I just spoke with Gary and his team, and I think he’s as grounded and focused around a smaller number of higher return opportunities in the decade I’ve known him. I’m willing to backstop that.
It's funny…people think that GF is a product/merch guy. But if you tell him “Gary, I feel xxxxx.” He’ll probably say “I don’t give a xxxx what you feel, I care what you THINK.” I think he’s got this business under lock and key right now. And more importantly, he’s delegated to a group of people (Office of the President) who are best in class – and comped accordingly. Do I worry about Karen Boone no longer being in the room? Yes. She earned my trust and respect. But Ryno’s got some chops…
So simply put…are these goals doable? Let’s rehash them…
- Stepped up design gallery growth from 3-5 to 5-7 per year, with the help of a ‘smaller’ prototype of 18k feet (about the size of Greenwich). Based on our math there’s another 50 markets – or a decade’s worth of growth – that could support a design gallery of 20k ft or better. This new smaller prototype is a bankable strategy.
- 8-12% Sales growth, aided by new categories like Beach House and Color (the latter is a big one). Check out the patent office for RH brand patent names. More extensions to come.
- Margins in mid-high teens. I think Gross Margins have 100-200bps upside ENTIRELY driven by occupancy leverage given what Stanchak is doing to structure new deals. This is such an underappreciated part of the story. Will I front the company with high teens margins in my models? No. They’re gonna have to earn it. But can I model 200bp of GM upside and 100-200bp of SG&A leverage as corporate can still scale? Yes.
- EPS growth of mid-high teens annually (this is too low. Company is sandbagging. Sorry RH! It’s good that Hedgeye’s numbers aren’t on the wires and don’t skew the consensus)
- ROIC in excess of 50%. Things are going to have to go perfectly here. But even if it gets to 40%, there won’t be many four-wall retail concepts that could compete.
In nine out of 10 meetings I’ve had over the years, the question comes up as to whether the new stores are actually working. There’s really only one line item where this will get fleshed out – in the Return on Capital. It doesn't lie. The deals that Stanchak and team are striking are unlike anything being realized in retail today. They look expensive given the dramatic finished product but are capital-light, which not only opens up margin, but frees up capital and lessens downside leverage in the event of an economic downturn. There’s no way new these stores can be ROIC dilutive and have the parent company’s ROIC accelerate so meaningfully.
I know this story is messy. It's got hair. But being long RH here is still an out-of-consensus call. And I'm comfortable being a country-mile off of consensus on this one.
