Takeaway: We’ll add more RH when there’s more near-term controversy, but there’s big TAIL earnings power here that has yet to be recognized.

Below is a complimentary research note (RH | $40 in EPS Power = $700 Stock) published on 9/9/20 from our Retail analysts Brian McGough and Jeremy McLeanWe are pleased to announce our new Sector Pro Product Retail Pro. Click HERE to learn more.

McGough: "This Remains The Best Long-Term Retail Idea We Can Find" - flagshipphoto rh boston 2

We’ve stood by this idea since it was a $30 stock and have repeatedly said that if I (McGough) had to pick one name in retail to own over a TAIL duration, it’d be RH.

That view was astoundingly unpopular at times -- both personally and professionally. But based on what we see today, it remains the best long-term retail idea we can find.

I don’t really care about after-hours trading (even though it’s going the bulls’ way), or a few ticks in either direction. A few bucks in the stock is a rounding error. The big question here is when the consensus will recognize that this is a company with $40 in earnings power. As a frame of reference, it did $11.53 last year, and is on track to flirting with $15 this year.

At that earnings level, RH would have a mid-20s margin, and 50%+ ROIC. I know a mid-20s margin seems excessive, but when Friedman (CEO) threw out 20% as a long term target a few years back people thought he was a moron, or just delusional.

Lo and behold in 2Q margins clocked in at 21.8%. Translation = he was right, and you were wrong if you bet against him.

What multiple is all this worth? Well…we have to keep in mind that this company’s earnings stream is about as volatile as they come, and is extremely cyclical. Neither of those factors help a stock’s beta.

But with the global scale, scope and dominance the company is building and with those return characteristics, is it worth 15-20x earnings? Yeh… I think so…at least. That suggests a $600-$800 stock, and it’s currently trading at about $350.

To be fully transparent, RH sits on my Long Bias list (as opposed to Best Idea Long), meaning that taking all durations (not just long-term) into account, there are other places I’d invest my hard-earned capital first. I like to go heavy into RH when there is some form of near-term controversy, or the company is investing in to achieve in the $40 in EPS power at the expense of a couple of bucks today. We’re definitely not at that point today.

There will come a time when people get beared-up over RH because the company misses a quarter and takes down guidance for a given year. Trust me…its happened before and will happen again.

But it’s building a unique track record for innovating and building a model that ultimately leads to market share gains and incrementally positive shareholder returns.

The bottom line is that we’re taking up our numbers by 10% to $18.50 next year and $25 in 2021, with a bias to the upside based on the company’s cadence in scaling an international model. My sense is that the opportunity to get heavier into controversy will be when RH builds its infrastructure in Europe.

That could be as soon as next year. Until then, good luck if you’re part of the 25% of the float that’s short the stock, you’re gonna need it.