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Jonathan Poland
Jonathan Poland
Articles (505)  | Author's Website |

Risk-Reward With RH

The company has benefited more from global recovery than durable competitive advantages

February 27, 2019 | About:

In the $116 billion home furnishings industry, there are very few luxury brands that people know regardless of where you live. Williams Sonoma (NYSE:WSM) is one, RH (NYSE:RH) is the other.

When price is not a consideration, the company, which was formerly known as Restoration Hardware, is a clear choice. Having visited many across the country, its showrooms are truly magnificent. The business model will survive the digital transformation because, despite cool augmented reality features available online, furniture still needs to be touched and tested before being purchased.

The recent assessment by Citron Research, the firm of activist short seller Andrew Left, is that “The holy grail of retailing is to create a multi-generational venue where people congregate and obtain an emotional attachment to the brand that supersedes the products sold in stores. There are only two companies doing this on a grand scale: Apple… and RH.”

Not so fast.

I’m sure many other retail executives would have something to say about this. Also, Apple (AAPL) isn’t a retail company; never has been, never will be. So I guess that leaves only RH. The reality is RH’s stock has risen too much, too fast and once tax breaks and debt loads from all the historical preservation it is doing is weighed in, the stock will not stay at these high levels. As a result, there is a good chance the stock will not reach Citron Research's price target of $250 before dipping below $100.

The company recently announced it will potentially offer up to $300 million worth of convertible notes due 2023 in a private offering to qualified institutional buyers. This will keep shares relatively flat for the time being.

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Long term, the brand will survive. People will still buy more expensive furniture because it can usually withstand the test of time. However, the stock and the company both face headwinds. Approximately 34% of the shares outstanding are sold short. And, while CEO Gary Friedman believes the company has no peers, investors should be leery of any executive leader that seems cavalier to competition.

2019 earnings are slated to be around $9.50 per share. At $150, the forward price-earnings multiple is close to 16, which is not really a bargain price. But the real problem is if it believes there’s a moat around it when there’s not. Sure, times are good right now as the retailer has turned around its business, but even with its 70 gallery-style furniture stores, it needs to sell more stuff in order continue growing.

If the price were to fall back 30% to $100 per share with the same financial strength, paying 10 to 12 times earnings for RH would make sense. For now, it doesn’t make sense, especially given that one of the first expenses people sidestep in a recession is buying furniture. Investors should not confuse the recent short-term market bounce for a bear correction the market has blown past.

The big correction is still on the horizon. RH is not going to be immune to it either. While it’s perfectly normal for Friedman to be excited about international expansion, earnings will get blasted if it attempts to grow too fast and the local economies cannot handle it. RH may not be a sell, but it’s definitely not a buy yet.

Disclosure: I am not long or short any stocks mentioned in this article.

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About the author:

Jonathan Poland
I spent more than 15 years helping DIY investors earn over 30% a year. Today, I help business leaders take those insights and build better assets. I rarely write about stocks that I own. Thanks for reading. Do your own analysis before investing.

Visit Jonathan Poland's Website


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