Operating on the other side of the retail value spectrum than Overstock.com Inc. (OSTK, Financial) is RH (RH, Financial). Formerly Restoration Hardware, the company is an upscale home furnishings company headquartered in California that operates predominantly in the U.S. RH sells high-end home furnishings and accessories through its physical retail stores, catalog, and e-commerce websites. As of Jan. 29, the company operated a total of 67 galleries, 38 outlet stores and 14 Waterworks showrooms in the U.S. and Canada. Waterworks is a separate retail brand that focuses on kitchens and bathrooms.
The core RH product lineup includes furniture, lighting, textiles, bathware, décor and outdoor products. The company targets wealthy consumers with incomes of $250,000 or greater. Over the last decade, RH has transformed itself from a retailer of unique collectibles and decorative items to luxury furniture and home goods.
The company was a strong beneficiary of the Covid-19 pandemic lockdown issues and the related home improvement boom. The stock has declined 55% from its 2021 highs as sales growth is expected to moderate and return to normal levels. RH currently has a market capitalization of $8.2 billion.
Inflation
During the company’s fourth-quarter and fiscal year 2021 conference call on March 29, CEO Gary Friedman made some notable comments regarding inflation. He was trying to make a point that retailers are out on the front lines when it comes to recognizing and dealing with inflation as compared to poor government transparency and actions.
Friedman said:
"I just wonder if anybody at the Fed has picked up the phone and called a business person and said, 'Hey, what do you think is happening with inflation? How's ocean rates? How is this? How is that?' I mean, I think, I don't think anybody really understands what's coming from an inflation point of view, because either businesses are going to make a lot less money, or they're going to raise their prices. And I don't think anybody really understands how high prices are going to go everywhere, in restaurants, in cars and everything. It's -- and I think it's going to outrun the consumer. And I think we're going to be in some tricky space."
Fiscal year review
The company’s fiscal year ending January 2022 showed exceptionally strong revenue growth of 32%, driven by continued high demand for luxury home products as well as parts of the supply chain issues being resolved and catching up with consumer demand. Operating margins also improved to 25.6% from 21.8% in the prior fiscal year. Net income increased 66% to $767 million and adjusted earnings per share increased 46% to $26.12 per share.
RH traditionally generates strong free cash flow when times are good. Over the past three fiscal years, free cash flow has been $476 million, $390 million and $245 million. The company has $2.18 billion in cash on the balance sheet, however, that was largely due to $2.0 billion in borrowings during the fiscal year.
The company believes it has the financial strength to take advantage of opportunities that may come up during any economic conditions. Yet management is still cautious on the current fiscal year and mentioned that demand softened when the Russia-Ukraine conflict started.
Valuation
The company’s guidance for the current fiscal year calls for net revenue growth in the 5% to 7% range (compared to 32% last year) and adjusted operating margins in the 25% to 26% range (compared to 25.6% last year).
Consensus analyst earnings per share estimates for this year are $25.50 and $28 for next year, which puts RH stock selling at only 13 times earnings. The company is trading at approximately 7 times Ebitda currently. RH does not currently pay a dividend, but has plenty of free cash flow to initiate one. A conservative discounted cash flow calculation puts the value of the stock about 13% higher than today's price.
Guru trades
Gurus who have purchased RH stock recently include Joel Greenblatt (Trades, Portfolio) and Steve Mandel (Trades, Portfolio). Gurus who recently sold or reduced their positions include Lee Ainslie (Trades, Portfolio) and Ray Dalio (Trades, Portfolio).
Conclusion
RH appears to be undervalued based on low price-earnings ratios and modest enterprise value/Ebitda levels. Also, the company has plenty of growth opportunities through store expansion across the U.S. In times of economic distress, it has sufficient liquidity to take advantage of potential distressed situations with real estate or other retailers. Finally, with a market cap of only $8.2 billion and with the stock trading at low valuation levels, the company could make an attractive acquisition target for a large-cap retailer.
