Here's Why Citron Research Loves This Retail Stock

This company's valuation is wildly mispriced; shares look to have 100% upside

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Ryan Vanzo
Apr 18, 2019
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Citron Research is one of the most well-known short-sellers today. With deep-dive calls on controversial stocks like Tesla (

TSLA, Financial), Aphria (APHA, Financial) and LYFT (LYFT, Financial), Citron has amassed an impressive reputation for quality research.

While most investors focus on Citrons short recommendations, the organization also has a variety of long positions with compelling stories. One of its most recent buy recommendations is $2.4 billion retailer RH (

RH, Financial).

With shares trading at just $111 a piece, Citron sees more than 100% upside, setting its price target at $250 per share.

What does Citron like so much about a brick-and-mortar retailer? Is its $250 price target reasonable?

The numbers dont add up

In its report, Citron called RH the most compelling story in retail. That doesnt inspire a great deal of confidence considering the S&P Retail index (

XRT, Financial) rose just 8% over the past five years compared to a 55% rise for the S&P 500 index (SPY, Financial).

Citron suggested that RH isnt your traditional retailer, however.

Often, Wall Street analysts compare RH to companies like Ethan Allen (ETH), La-Z-Boy (

LZB, Financial) and Williams Sonoma (WSM, Financial). Its a comparison that seems to make a lot of sense.

RH operates in the $109 billion home furnishing industry. Its stores sell furniture, lighting, textiles, bath accessories, general decor and more. Given its overlap with the companies listed above, RH trades roughly in line with its peer group.

RH

ETH

LZB

WSM

FWD P/E

13.3x

13.4x

14.9x

12.4x

P/S

1.0x

0.7x

1.0x

0.8x

EV/EBITDA

9.8x

7.5x

9.5x

7.1x

But theres a catch. None of the companies listed above should be considered part of RHs peer group at least according to Citron. Looking at how quickly each company has grown its earnings over the last five years demonstrates Citrons point without even going into why RH is in a class of its own.

RH

ETH

LZB

WSM

5-Year EPS CAGR

29.1%

-2.2%

11.9%

5.1%*

*Only 4 years of available data

Citrons main argument is that the market has missed RHs business transformation over recent years. And while the fundamentals continue to sizably outpace the rest of the home furnishing industry, the stock market has rewarded RH with the same depressed valuation as its supposed peer group.

If RH were in any other sector, it would be assigned a premium valuation to the market as a whole. Because it operates in the out-of-favor retail sector, investors and analysts refuse to assign it a proper valuation.

What has RH done differently to fuel its rapid earnings growth? Nearly everything.

This story has done a complete 180

Citron argued that the best way to understand RHs turnaround is through pictures, and theyd be right. Formally known as Restoration Hardware, here is what RH stores used to look like:

Take a look at some the companys supposed peers and youll understand why RH is still lumped in with that group:

If youve been to an RH store recently, however, it's unrecognizable. RH has been taking advantage of struggling retail property owners by forcing them to pay for major renovations. In 2019, RH was able to get landlords to cover 65-100% of the costs needed to revamp its aesthetic presence.

Here's what RH stores look like today:

Instead of merely being a retailer, RH has focused on making its locations an experience, similar to an Apple (AAPL) store. As Citron wrote in its report, The store is no longer just a place to buy products it is the product. Visit any location near you and it would be hard to argue otherwise.

The transformation has been surprisingly asset-light. As mentioned, much of the costs are fronted by landlords. Its also been able to secure square footage rates around 50% lower than its former mall-based stores. Its actually been good business to be a thriving company in a troubled industry.

How much are shares really worth?

Before pegging a value on shares, its important to note that the companys CEO, Gary Friedman, is incredibly incentivized to improve the valuation quickly. Based on fully diluted shares, he owns around a quarter of the company.

I'm the biggest shareholder in the company. I have the most to gain and I have the most to lose here. This is like 97% of my net worth. This is not a casual investment. RH CEO Gary Friedman

Citron thinks that RH ultimately will be bought out, finally garnering the valuation it deserves. A trading price at the same level as La-Z-Boy and Ethan Allen would likely be absurd to a private equity shop. Still, theres room for value even without an outright acquisition.

This year, RH anticipates earnings per share around $8.41 to $9.08. Even using the bottom end of that range, shares trade at just 13.3x forward earnings. The S&P 500 trades at a forward price-earnings ratio of 17.5.

Using a 10% discount rate and a terminal growth rate of just 3%, RH would need to grow earnings by just 3.66% annually to justify its current valuation.

Over the next five years, the analyst consensus is for RH to grow profits by 25.5% annually. That disparity leaves a hefty margin of safety.

Now trading at a discounted valuation despite a rosy long-term forecast, RH stock looks like a mispriced bargain.

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Ryan has been covering public equities for more than a decade. He has worked on the investment research teams for several multi-billion dollar hedge funds in San Francisco and New York.