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RH: Home Furnishing Star Trapped In Transition

|Includes: RH (RH)

Basic Information:

  1. Home furnishing industry has been growing twice as fast as GDP since 09 crisis, and the increasing polarization of the world has become the backdrop of the development of high-end and low-end consuming.
  2. By keeping up-grading product lines and giving up vertical integration, RH had been the rising star of US home furnishing industry and gained four straight years of comparable brand growth over 25%, and since 2012 IPO, share price more than tripled to over 100 in two years.
  3. Trapped in Transition since the end of 2015----Revenue growth stalled and profits plummeted:
    • Adding new product lines: Added RH Modern in June 2015 and Teen on the fourth quarter of 2015, and suffered shipping delay and inventory shortage for a whole year;
    • Reshaping small, mall-based shops into big up-scale big, glamourous stand-alone art galleries with wine vaults and coffee bars;
    • Introduce RH Grey Card in March 2016 to replace promotion;
    • SKU rationalization (probably from previous fast growth);
    • Organization structure adjustment, creating the office of the President and three CMO (Chief Merchandising Officers) positions, and hiring talents with cross-industry experience.
    • Resource book printing and mailing delay (repeatedly) might signaling
    • Acquired Waterworks (a luxury bathroom products provider), a small restaurant chain and a wine vault.
    • Bought trucks to improve delivery experience.
    • In 2015, it added RH Modern and RH Teen to its existed product series of Contemporary and Baby&Kids.
  4. Major Competitors: ETH, WSM (Pottery Barn & West Elm), Our House, HVT

Risk and Opportunity Score:

 

Near Term

(Recent Two weeks)

Medium Term

(Before the end of March 2017)

Long Term

(1 year)

Risk/Opportunity

60 50

30 60

30 80

Low/High Price Target

28 34~35

33 ? 45 ?

? 70~80

Near Term Risk:

  1. Recently retail stocks are in headwind in general.
  2. Investors who worry that RH might not 'bottomed' might go on selling off.
  3. Next quarterly reports at the end of March and guidance will be very important. Actual expectation for Q4 results is higher than RH's guidance, thus if RH miss, stock price might plunge again

Stock Price support:

  1. Problems that previously negatively affected revenue growth had been mostly solved.
    • Modern products have been in stock;
    • Source book mailed;
    • RH Grey Card seems to grow well with 5k to 8k new members signed weekly;
  2. Meeting estimates during the recent two quarters, albeit revenue growth stalled and comparable sales declined, means the organization has been stabilized and got predictable again.
  3. Advance shipment in the second quarter show signs of supply chain improvement.
  4. The three excuses CEO given for lowering fourth quarter guidance were largely legitimate, and the negative effects of them were short-living.
  5. Positive macro economic environment and expectation of an imminent turnaround in 2017.

Investor Concerns :

  1. The rout RH has experienced hasn't ended yet, or might even get worse:
    • Concerns on organization capacity and management problems aroused by delayed source book and other things.
    • Free cash flow pressure from aggressive expanding.
  2. Analysts questioned future growth and profit possibility, thus a turnaround might not exist:
  • There might be demand problem hiding behind: the aesthetics of RH Modern might not be accepted by consumers.
  • The business mode with board products with a very long tail might exacerbate SKU problem thus worsen profitability.

Near Term Narrative:

  1. Relatively low evaluation brings more upward potential than downward risk: ttm P/S of just 0.56, while WSM (yoy flat) is 0.9 and ETH is 1.3 (YoY comparable sales +6%);

My Understanding on RH's problems during the past year:

  1. Previous fast growth has covered many problems, including high inventories of SKU (Stock-keeping Unit) from long-tail products and management problems, and they revealed when growth stalled.
  2. According to CEO, new product line faced supplier shipping delay for more than a year, which has negatively affected revenue growth. Such was an eligible explanation because ETH also mentioned they used a whole year to teach factory to make new products.
  3. During the year of transforming, RH has been keeping testing and adjusting, which might bring pressure and confusion to employees.
  4. RH has relatively low comment from employees on Glassdoor, and major cons are (1) Very high pressure; (2) Favoritism. From my point of view, there isn't really 'favoritism' in a high-pressured environment because every manager needs performance. So I rather see it as a pro of the company: flexible in HR.
  5. No-promotion can negatively affect revenue, yet it is reversible.
  6. Reasons of for lowering Q4 guidance----(1) Delayed mailing source book; (2)Its decision to remove seasonal/holiday merchandise; (3) Election uncertainty. The latter two reasons are legitimate because all other retailers, ETH, HVT, WSM, have mentioned election uncertainty had kept customers sit sideline.
  7. Not being able to mailing source book on time (especially which was the second time….) proved some level of chaos in management.

Long-term outlook: Cautiously Bullish

  1. CEO is a bit narcissistic, but is visionary and ambitious, reacting swiftly to market change, bench-marking competitors, keeping thinking, experimenting, innovating and adjusting, and by no means arrogant.
  2. Best design taste in furniture industry; integrated dinning and accommodation will bring more customers to RH's gallery, thus defending against declining customer volume.
  3. There's an extraordinary high-pressure culture in the company, which is the gene for fast-growth and quick adjustment.
  4. Bearish case:
  • Organization ability keeps lagging behind CEO's vision, thus creating more choas.
  • Debt-boosted growth might bring pressure to balance sheet.
  • Can RH's aesthetics being accepted by the market? If not, RH has the ability to adjust, but it needs time;
  • Giving up promotion might not work, giving its lofty price, and RH might go back to heavy promotion, thus hurt profitability.……

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.