New Position: Restoration Hardware (RH, Financial)
We started acquiring RH in Q4 of 2020 when the market started to fear what a “Blue Wave” and peaking “work from home” could mean for high-end furniture demand. Our focus was less on those issues and more on a high-quality underlying business at a fundamental inflection point. Our confidence was buoyed by CEO Gary Friedman, a once-in-a-generation leader who is both an innovator and effective capital allocator.
Furniture companies are not known for their high returns on invested capital, and a common bear thesis on RH was that furniture companies had never sustainably earned >10% EBIT margins (which RH had recently exceeded). However, in the same way that Ferrari should not be compared to other auto manufacturers, we believe RH should not be considered a traditional furniture company. Gary Friedman has employed a methodical strategy that
involved improving product quality and design, supply chain efficiency, retail presentation, and essentially eliminating discounting. The result is the ability to command higher product gross margins, better leverage on fixed costs, and a unique advantage in retail, where landlords basically pay RH to anchor retail properties, as RH’s stores draw high-income traffic and create a “halo effect”. Financially, this has translated into EBIT margins in the mid 20% range and an eye popping >60% ROIC.
When work from home produced a surge in furniture demand, skeptics wondered if RH could sustain its recent revenue growth. Yet, bears missed the fact that the intentional “elevation” of the brand had actually restrained sales for the preceding few years. This strategy shift was only just manifesting into a growth phase when COVID hit. Coming out of COVID, we expect the years of hard work to pay off, driving years of above-consensus furniture growth domestically. Beyond the US, RH plans to begin an aggressive international expansion starting with a flagship England store in the spring of 2022 and a total of 10 European locations in the next two to three years. Like all great luxury companies, RH has also realized that its design competency and brand cachet extend beyond its core product category, and they are expanding their TAM to include residential real estate development, lodging, restaurants, and more – and are pursuing this growth with a capital-light, high ROIC philosophy. We are confident in RH’s potential for rapid earnings growth and multiple expansion as Friedman continues to execute on his vision, regardless of the political landscape or housing cycle.
From Daniel Loeb (Trades, Portfolio)'s Third Point second-quarter 2021 investor letter.
