RH: Luxury Margins Mean Luxury Returns

RH (RH), formerly Restoration Hardware, is a luxury furniture retailer in the United States and Europe. Unlike stores with a traditional cash-and-carry retail model, RH operates galleries in which customers view the items in the gallery and then order for later delivery. RH also operates luxury restaurants and guest houses.

I am bullish on RH stock. (See Analysts’ Top Stocks on TipRanks)

A Great Transformation

RH was formerly known as Restoration Hardware. The company began as a more traditional cash-and-carry (CAC) retailer. After struggling for several years, the company underwent a vast change in model in 2016. Instead of the CAC model, it became a subscription service, with catalogues sent to members at regular intervals. Initially, this innovative move was not well received by analysts or investors.

The new model was the vision of CEO Gary Freidman. He imagined a luxury subscription model with an air of exclusivity. The model has proved to be very forward-thinking, in light of the continued rise of ecommerce. Customers may shop at a gallery or via catalogue, but all items are shipped to their homes. This was especially important during COVID-19, however it has made way for luxury margins generally as well: an investment of $10,000 fives years ago in RH stock would be worth over $228,000 today.

Recent Results Impressive

During this five year period quarterly revenues are also up significantly. The Q2 fiscal 2022 revenue was up over 80% from Q2 five years prior. On a shorter time frame, revenues are up 48% over the January 31, 2020 quarter end- the last full period before the COVID-19 disruption. Note that the company runs on a January 31 fiscal year-end.

The advantage to selling luxury items is in the margins. Higher-end items carry premium pricing power, which allows the company to make more money selling less volume than competitors. RH has better operating margins, EBITDA margins, and net margins than Williams-Sonoma (WSM), Wayfair (W), and Amazon (AMZN). For example, RH has an EBITDA margin over the trailing twelve months (TTMs) of 23.49%. This compares favorably to Williams-Sonoma at 18.92%, Amazon at 14.63%, and Wayfair at a paltry 5.29%. The results are similar across the board, with RH the clear leader in each profitability metric mentioned.

It is important to note that RH also has higher growth estimates than the others mentioned, at 32% estimated for the current fiscal year. This eclipses Amazon at 23% and Williams-Sonoma at 20%. Wayfair is expected to eek out just 1% in revenue growth.

One would expect RH to have a very high PE ratio given these metrics, however the company’s forward PE of 26.16 is quite reasonable. Analysts are predicting only 10% earnings growth in fiscal 2023, which may be weighing down the valuation.

Additionally the company’s European expansion is set to deliver in 2022. After delays, management will open galleries in Paris and the U.K. If these prove successful, its international expansion could spur outperformance.

Supply Chain Issues May Hurt Margins, Timing

One potential risk for RH is that the company sources its raw material and manufactures its products overseas. The recent supply chain bottlenecks have caused delays in getting products to customers. Indeed, the Delta Variant has disrupted global supply chains across industries.

Moreover, the supply problems could lead to inflation. These supply chain issues may be persistent and cause costs to rise. When this happens, it puts pressure on margins. As of Q2 this has not shown up in the financial results of RH; however, it is a concern to watch.

Wall Street Opines

Over on Wall Street, analysts are extremely bullish on RH stock. 10 analysts have Buy ratings, to go along with three Holds and zero Sell ratings.

The average RH price target of $793.92 implies 18.9% upside from the current price.

Summary on RH

RH has undergone one of the more successful transformations of any company on Wall Street over the last five years. The company continues to stress luxury and this allows for impressive margins. Additionally, the expansion into Europe has been in the works for several years and is slated to come to fruition in 2022; this could help management beat estimates once again. Therefore, RH could be a good Buy for long-term investors.

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Disclosure: At the time of publication, Bradley Guichard had a position in securities mentioned in this article.

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