Home Improvement Battles: Haverty or Restoration? Perhaps Neither Will Do

On August 20, 2006 Philip Davis published an article and a comment on Seeking Alpha explaining why America’s twenty million millionaires would be opting to refurbish and remodel their existing homes rather than buy a new one. One of the recommendations for this play was Restoration Hardware (RSTO).

Reading a review on Alexa about Seeking Alpha, a reviewer perceives Philip Davis as a contrarian author. There probably is some basis for this observation as to be a successful options trader one must possess a psyche that is constantly one step ahead of the market. Philip may be ahead of the market again.

The Home Furnishing Retail Index has been in the doldrums for most of 2006 and has declined so far by 7%. Both HVT and RSTO target upper middle income consumers. Both work with private interior decorators to appeal to the high end.

Haverty Furniture Companies Inc. (HVT)

HVT operates approximately 118 retail stores for living room, bedroom, dinning room furniture and other household accessories such as bedding etc. HVT strength is in living room furnishings, though it carries a wide array of residential furnishing products.

Restoration Hardware Inc. (RSTO)

RSTO manufactures office and home furniture and operates approximately 109 retail stores for furniture, lighting, bedding & towels, bathroom ware (including tubs, showers, cabinets etc.) and other household accessories. RSTO is known more for its bathroom remodeling selections.

Philip Davis recommends buying RSTO and not to dump this flush (wash out). RSTO is growing sales at a healthy clip (13% YOY) while HVT same store sales are stagnant.

Based on the limited research done to date I agree with Philip that RSTO should be doing a lot better over the next 6 to 12 months, reason being is that they are showing continuous growth in sales. However RSTO is NOT an investor friendly company and comes with a ‘high risk’ warning label.

In general new start ups are expected to pay their top executives with stock options in order to use generated cash to grow the company. RSTO is not a startup. The company was founded in 1979. Throughout fiscal 2005/2006, RSTO issued stock options to no less than 8 directors and senior officers. In addition, existing options exercised and open market acquisitions from 5/2005 (Q2) through 4/2006 (Q1) are as follows:

If they continue to do what they have been doing for the past 25 years, at the first sign of a profit new stock options will be issued eliminating all shareholder profit. Instead of paying down their debt management is focused on paying themselves. Apparently RSTO doesn’t like paying income tax or dividends to shareholders.

Notice that the Chairman and Directors bought the bulk of shares at $1.99 which just happens to be the book value per share.

HVT on the other hand is stuck in slow growth mode. Contrary to RSTO their top line is not expected to perform very well in 2007 and they are concentrating on squeezing out higher profits by selling more private label merchandise resulting in higher profit margins. Also contrary to RSTO, HVT is an investor friendly company and is looking for ways to enhance shareholder value. HVT takes great pride in the fact that the company never missed a dividend payment since 1935. The problem I have with HVT is I don’t think they have figured out how they are going to cushion themselves (pun intended) against a slowdown. On the other hand, if Philip’s hypothesis is correct, there won’t be any slowdown for these two.

So who should it be - friendly, unfriendly or none of the above?

HVT-RSTO 1-yr comparison chart: