RH (RH)

[MiamiGent]

RH How Furniture Retailer RH Pulled Off Its Surprising Turnaround
BY MarketWatch — 7:35 AM ET 01/07/2019

Two years ago, RH, formerly known as Restoration Hardware(RH), was in the dumps (https://www.wsj.com/articles/ logistics-woes-crimp-restoration-hardwares-modern-collection-1459207483?mod=article_inline). The stock was down and short sellers were piling in. RH fought back, revamping its business model and adding risk by borrowing to buy back half its stock (https://www.wsj.com/articles/one-retail-ceo-has-bet-1-billion-to-fight-skeptical-investors-1514383673).

The buyback helped crush the shorts and the new strategy made RH one of the great retail turnaround stories.
But is it sustainable?

RH improved quality and raised prices, setting itself apart from rivals like Pottery Barn and Crate & Barrel, while forging important relationships with interior designers. "They used to cater to the top 10%," says Anthony Chukumba of Loop Capital. "Now they're catering to the top 1%."

It has built out its stores, which are big advertisers for the brand, while at the same time adding amenities such as restaurants and wine bars that drew in traffic.

Other initiatives have helped, too. The company has reduced inventory, closed distribution centers and introduced a membership program (https://www.wsj.com/articles/what-restoration-hardware-can-learn-from-j-c-penney-1459698948?mod= article_inline&mod=article_inline) that draws consumers on a steady basis instead of through sporadic promotions. RH, wrote Wedbush analyst Seth Basham, is "a luxury brand with no peer."

The stock has climbed 27% in the last 12 months, reaching a high over the summer. When it reported third-quarter earnings (https://www.wsj.com/articles/rh-raises-forecast-as-organizational-changes-improve-profits-1543877713) in December, investors were particularly elated. The company reported year-over-year earnings growth of 66% and revenue growth of nearly 8%. It also raised its guidance for the fourth quarter, ending Feb. 2, and for its next fiscal year.

With the business humming, one question is whether RH borrowed too much to beat back the shorts. On that count the retailer looks OK. At the end of the third quarter, it had $959 million worth of debt. Some of that debt will mature this year and next. That would have been a concern two years ago when the company's free cash flow was negative. But now the company says it expects free cash flow of around $260 million for this fiscal year and a similar figure for fiscal 2019.

A second concern might be a downturn in the housing market or additional tariffs on Chinese imports. China accounted for around 40% of RH's purchases in 2017; that number is expected to decline as the company gradually shifts production elsewhere. Even if tariffs drive up costs, though, analysts say the company can easily pass along them along to their affluent customers.

Trading at 11.5 times forward earnings, RH's stock commands about half the earnings multiple it has on average over the past five years. Investors also should be encouraged by the fact that Chief Executive Gary Friedman is now also the largest shareholder. As Mr. Chukumba points out, "Management has a ton of skin in the game. They're in it together."

Write to Elizabeth Winkler at [e-mail]

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