Restoration Hardware Holdings: Margin Improvement Should Drive Valuation

| About: RH (RH)

Restoration Hardware Holdings (NYSE:RH) made its public debut on Friday, November 2nd. Shares of the innovative and fast growing luxury brand in the home furnishings marketplace ended their first day with gains of 29.6% to $31.10 per share.

The Public Offering

Restoration Hardware is an innovative and fast growing luxury brand in the furnishing marketplace. The company has achieved superior sales growth and market share gains over the past years in the differentiated home furnishing industry. The company operates 73 retail stores in the United States and Canada, and 10 more outlets as of July of this year.

Restoration sold 5.2 million shares for $24 a piece. Restoration raised $115 million in gross proceeds in the offering process. Based on the offer price of $24.00, the furnishing company is valued at $888 million.

The offering is quite a success. The offer price was set at the high-end of the preliminary $22-$24 price range set by the firm and its bankers. Some 4.78 million shares were offered by the company, while selling shareholders offered almost 382,000 shares.

In total, 14% of Restoration Hardware's shares outstanding were offered. At Friday's closing price of $31.10 per share, the firm is valued at $1.15 billion.

The major banks that brought the company public were Bank of America/Merrill Lynch, Goldman Sacs, Piper Jaffray, Baird and William Blair, among others.


Restoration Hardware has a good track record in growth, innovation and integration of product categories. The company is rapidly scaling up to fully integrate its multi-channel infrastructure in order to continue growth and boost margins.

The company reported annual revenues of $958.1 million for 2011, up 24.0% on the year. Restoration reported a net profit of $20.6 million, compared to a loss of $7.1 million the year before.

Revenues for the first six months of 2012 rose 21.5% to $510.8 million. The company reported net income of $13.9 million compared to a modest profit of $1.4 million in the first half of 2011.

Restoration Hardware will receive $115 million in gross proceeds from the offering. Some $85.7 million will be used to repay a portion of the revolving credit line outstanding.

The company will operate with cash and equivalents of $3.9 million, on a pro-forma basis. The company operates with a total debt position of $57.2 million, for a net debt position of roughly $53 million.

Based on a full year revenue estimate of roughly $1.15 billion, the market values the firm at 1.0 times annual revenues. Net income could come in around $35 million, valuing the firm at 32-33 times annual earnings

Investment Thesis

As noted above, the offering of Restoration Hardware is quite a success. Shares opened at $32.05 per share on Friday and ended the day with strong gains of 29.6% at $31.10 per share. As such, shares are still trading some 35.2% above the midpoint of the initially guided price range.

The company intends to retain all available funds and any future earnings for the operation of its business. As such, Restoration Hardware does not anticipate to pay any cash dividends in the foreseeable future.

An investment in Restoration is a bet on continued strength in the U.S. housing market. Restoration sells housewares such as furniture and lighting, and a continued recovery of the housing market boosts the prospects for the coming years. Strong consumer confidence readings and better than expected payroll numbers are positive signals as well.

Shares are fairly valued at 1.0 times revenues. The earnings multiple is a little rich at 32-33 times annual earnings. However, the company has shown rapid earnings growth in recent times. Some of Restoration's competitors include Pier 1 Imports (PIR) and Williams-Sonoma (WSM), both are listed as well.

Pier 1 Imports is valued at roughly $2.2 billion, or 1.4 times annual revenues and 13 times 2011s annual earnings. Pier 1 has much higher net margins at 11.0%. Williams-Sonoma is valued at $4.6 billion, or 1.2 times annual revenues. Williams-Sonoma trades at 19 times 2011s annual earnings, and reported net margins of 6.4%.

With comparable sales growth coming in at 31% in the second quarter, I think that shares look very appealing. While Restoration shows superior growth, it is trading at a revenue discount compared to some of its competitors. The key reason is the lower profit margins. Restoration's margins are only half of those of William-Sonoma and only a quarter of Pier1. The company reported losses for the full year of 2010 and 2011 and is rapidly boosting profitability.

Despite the decent first day rally, I think that shares continue to offer excellent long-term potential. As always, it remains very difficult to make any prediction on short-term price action.

Disclosure: I 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.

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