RH Is A Best-Of-Breed Retail Stock

About: RH (RH)
by: Leo Nelissen

RH did it again, the company crushed expectations in its just released second quarter.

The store transformation and margin enhancement are working as sales, margins and earnings have reached new all-time highs.

Despite the ongoing trade war and slower economic growth, RH has once again raised its full-year guidance.

Over the past few weeks, I have reviewed quite a few retailers. Some were struggling retailers working on a recovery, while others already had found a way to continuously increase shareholder value. RH Inc. (RH) is one of the latter companies. The company's stock price got absolutely destroyed in 2016 after which the company increasingly focused on value creation. The company has made tremendous progress and just released an impressive second quarter. All indicators I watch when analyzing retail companies are showing great results and I have no doubt this company will continue to do very well in the long-term. Source: RH Inc.

Everything Is Up

One of the cornerstones of RH's strategy is the focus on customer experiences through high-end galleries. In my previous article, I already highlighted the introduction of RH Beach House and the continuing expansion of products.

We remain cautiously optimistic that business momentum will continue despite negative macro trends and increased tariffs, supported by the recent introduction of RH Beach House, the continued elevation and expansion of our product offering, investments in RH Interior Design, plus the launch of RH Ski House and new galleries opening this fall. (Source)

The company ended the second quarter with 85 stores which is unchanged compared to the prior-year quarter. Average selling square footage increased by 4%.

At this point, the company is reaping the rewards as adjusted EPS has hit a new all-time high in the second quarter. Adjusted EPS reached $3.20 which is way above expectations of $2.70. Since the fourth quarter of 2017, the company has reported only blowout earnings. None of the estimates were actually really close to the actual number. In the just released quarter, EPS accelerated by 29% which is the 10th consecutive quarter of positive earnings growth.

Source: Estimize

The ongoing focus on elevating the brand, its architecture and integrated operating platform has resulted in RH being one of the few retailers with growth in all key areas. These key areas in my opinion are sales, margins and bottom line growth. Retailers that struggle to improve margins often try to boost sales to save the bottom line. This often results in additional pressure on margins as products are sold at lower prices. To be fair, most of these companies are apparel retailers.

Regardless, RH has done everything right. Sales improved by 10% to $707 million. In the first quarter of this year, sales growth reached 7%. Growth was generated in the company's galleries. Mainly the RH New York continued its expansion. Additionally, the company benefited from shipping efficiencies.

And speaking of efficiencies, GAAP operating margin hit a record high at 14.7%. Adjusted operating margin also reached a record of 14.9%.

The graph below incorporates everything mentioned so far. Sales have been in a steady uptrend since the end of the recession. However, just like many competitors, the company ran into trouble in 2015 when margins started to decline. That's when the company decided to focus on the bottom line only instead of sales. What followed was a period of weak and volatile sales growth but rising margins.

Moreover, the company continues to show that the turnaround is working as we are currently witnessing both higher sales and higher margins which have pushed earnings to a new record high.

It even gets better, the company expects this win streak to continue despite the headwinds from tariffs and a slower economy. Personally, I was a bit surprised when management mentioned a slower economy as most housing related companies have not yet mentioned any slowing whatsoever.

Despite the increase in tariffs and some negative macro trends, we remain optimistic that our business momentum will continue, supported by a number of positive factors including by the recent mailing of the Fall Interiors and soon to be in-home Modern Source Books, the increasing contribution from RH Beach House, the launch of RH Ski House and new Galleries opening this fall.

And it's not just talk. The company raised its guidance for the third consecutive time in the second quarter. Sales expectations have been raised by roughly $30 million while operating margin could go as high as 13.8%. Net income could even hit $252.3 million compared to previous expectations of $223.8 million.

Source: RH Inc. Q2/2019 Earnings Presentation

And that's still not everything. Share buybacks continue to be a huge driver of shareholder value as management still believes that shares are undervalued. Year-to-date, the company has bought back 2.2 million shares at an average price of $115.4 (current price $167). Since 2017, the company has repurchased 60% of outstanding shares at an average price of $61.40 which not only shows the confidence management has, but also that the plan has worked quite well.

On a long-term basis, RH expects to grow sales between 8% to 12% on an annual basis.

The stock, which is trading at 15x next year's earnings is up 33% year-to-date and has almost doubled since the bottom of 2019 has a lot more upside potential on the long run in my opinion.

Source: FINVIZ

Although the company is seeing a slower economic environment, there is no sign of slower sales or pressure on margins as the updated guidance shows. It's also a good thing that a lot of retailers are struggling as money is rushing to the ones that are showing good results (like RH).

The past 4 monthly candles are incredible and I would not be surprised if the stock were to take a little breather. Nonetheless, the long-term is what counts and I would not bet against this company with my enemy's money. There are not many winners in the retail space, but this stock sure is one of the champions AKA a go-to retail stock.

Stay tuned!

Thank you very much for reading my article. Feel free to click on the "Like" button and don't forget to share your opinion in the comment section down below!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.