Is RH Stock Still Attractive At $389?

KIEV, UKRAINE – 2019/02/08: In this photo illustration, the Restoration Hardware Company logo seen … [+] displayed on a smartphone. (Photo Illustration by Igor Golovniov/SOPA Images/LightRocket via Getty Images)

LightRocket via Getty Images

Despite an almost 82% increase in RH stock (NYSE: RH) since the beginning of this year, at the current price of around $389 per share, we believe the retailer still has a modest upside. RH is an upscale home furnishings retailer, which was formerly known as Restoration Hardware Holdings Inc. The company’s stock plunged 62% between the beginning of the year and March 23, at the onset of the pandemic and temporary store closures. But RH stock gained a large 384% since then, on the back of increased core demand (dollar value of customer orders placed) from 7% in May to 47% in August. Despite flat revenues in Q2, the company was also able to grow its operating margins – resulting in the stock to triple in value.

The increase in demand indicates that the affluent (RH’s key demographic) stuck-at-home consumers are still shopping and spending on luxury goods. We believe that the stock could rally further given that the expectation around manufacturing increases and inventories catch up to demand in the long term. On the contrary to the general pandemic trend, RH is focusing on huge brick-and-mortar spaces and luxury pricing to a limited economic demographic. But this plan seems to be working well for the company and is offering market-beating returns so far. The retailer’s stock is around 350% higher than it was at the end of fiscal 2017, compared to 31% growth in the S&P. Our dashboard, What Factors Drove 350% Growth in RH Stock Between Fiscal 2017 and Now? provides the key numbers behind our thinking, and we explain more below.

RH’s revenues expanded by about 9% between 2017 and 2019, rising from around $2.4 billion to $2.6 billion. Its Revenue Per Share metric also grew 54% as shares outstanding declined 30% during this period. The strong fundamentals were supported by the markets as investors assigned a higher valuation to RH, with its P/S multiple expanding 61% from around 1.0x in 2018 to 1.5x in 2019. While RH’s P/S multiple stands at about 2.8x currently, we believe it can still grow modestly. The company’s business doesn’t have a true rival and it continues to keep growing by opening new retail locations using the capital-light method of sale-leaseback transactions. It’s also expanding its addressable market by operating restaurants, hotels, and other luxury experiences.

What’s the likely trigger to this upside?

RH is benefiting from the Covid-driven shift of spending in favor of the home. In Q2 (ended Aug 1), RH achieved a record adjusted operating margin of 21.8% on revenue of $709 million and net income of $98 million. This kind of margin from a furniture retailer is surprising. That said, RH does have substantial liabilities on the balance sheet but that doesn’t pose a threat to the solvency of the company. The $549 million of convertible senior notes bear no interest, and close to $1 billion in lease liabilities could be fulfilled as RH plans to open new locations in the years ahead. Going forward, the company’s management expects its operating margin to exceed 20% and return on invested capital to be higher than 50% for the fiscal year 2020.

Since RH caters to the wealthiest of the population, a volatile stock market influenced by the upcoming election result is a near-term headwind (as the net worth of high-income consumers is usually tied up in the stock market and real estate). However, these customers are relatively less sensitive to fluctuations in the economy. RH plans to grow through initiatives in hospitality, housing, and international development. And, all this while attracting customers through its paid membership model instead of promotions. Although the company management expects revenue growth to lag behind demand in the short term due to limited supply. The long-term outlook for the company remains robust making the stock attractive even at current levels, driven by persistently low-interest rates and supportive Federal Reserve asset prices.

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