Shares of RH (RH, Financial) jumped last week after Warren Buffett (Trades, Portfolio)'s conglomerate, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), revealed it had initiated a position in the furniture retailer.
According to Berkshire's 13F filing, the firm acquired 1.2 million shares of the company in the three months to the end of September, spending roughly $200 million to build the position.
It has a 0.1% portfolio weight, a relatively minuscule position in comparison to the group's $215 billion overall equity portfolio.
A big deal
While this holding might be a small position for Berkshire, it's a big deal for RH. Buffett's conglomerate is now the company's fourth-largest shareholder. It owns around 6% of the business.
Considering the size of the position, it is unlikely that Buffett himself pulled the trigger on Berkshire's RH investment.
Buffett usually only oversees the group's most substantial holdings; the smaller positions are left to his portfolio managers, Todd Combs and Ted Weschler. I think it is highly likely that these managers, rather than Buffett, made the decision here.
Still, it's interesting to see that these value-focused investment managers are interested in RH.
What's to like about RH?
At first glance, this business isn't particularly attractive from a value perspective. It is trading at a forward earnings multiple of 15.2 and price-to-free cash flow ratio of 15.6.
What the managers might be interested in is the company's new focus on creating a strong brand over pushing sales. RH has transformed itself into a high-end luxury brand, which involved changing its name from Restoration Hardware to RH. As part of this transformation, RH has also opened about 70 so-called RH Galleries, which are expansive, museum-style stores, and has adopted a membership model.
There are several similarities between this business model and other businesses Buffett has expressed a liking for in the past.
For example, Nebraska Furniture Mart operates large, no-frills stores, which allow it to undercut the competition and suck in customers. At the same time, both Buffett and his right-hand man, Charlie Munger (Trades, Portfolio), have praised Costco's (COST, Financial) business model of using customer memberships to produce profit while selling goods at cost.
A fan of Buffett
It's isn't much of a surprise that RH has adopted a business model that's loosely based around the sort of companies Buffett likes. Its CEO, Gary Friedman, is a fan of the Oracle of Omaha and has quoted Buffett on at least two occasions.
"If the market undervalues a company, as Warren Buffett said, if the skies darken and there's an opportunity it's going to rain gold, you want to run outside with washtubs and not teaspoons, right," he said on an earnings call in December.
At an investor day in November 2017, he said: "Warren Buffett likes to say, 'Time favors the well-led and well-managed company.'"
Then there's RH's growth potential. Speaking to investors on the company's earnings call in September, Friedman declared, "I think the opportunity internationally is probably — could be three to four times what we do in North America."
When you add all of the above together, in some ways, it is not surprising that Berkshire has decided to back RH. Having a good management team is vital if a company is to succeed over the long term, and any manager who pays attention to what Buffett says, or has said, stands out.
So far, Friedman's attempts to reinvent the business seem to be paying off. Net profit hit a multiyear high of $151 million in fiscal 2019, and Wall Street believes the company is on track to report net income of $254 million for fiscal 2020. If RH can repeat this success in Europe, then the company could be worth many multiples of its current price in several years.
So while the stock may not look cheap now, looking out five or 10 years, there could be a fantastic opportunity for investors here.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Warren Buffett: Develop a 'Bunch of Filters' to Say 'No' as Fast as Possible
- Warren Buffett: Growth vs. Cash Generation
- Mohnish Pabrai Boosts Holding of Deep-Value Investment in 3rd Quarter
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