Restoration Hardware: The Next Chapter of Growth

Restoration Hardware is trading higher after beating earnings expectations for the fourth quarter; however, it's the company's outlook that should have bulls excited about the future.

Mar 31, 2014 at 11:15AM

Restoration Hardware (NYSE:RH) traded higher by double digits last Friday after reporting earnings. However, it's not just the company's industry-leading growth that's exciting investors but also the company's decision to finally expand. While the industry as a whole has been weak of late, including Home Depot (NYSE:HD) and peer Lumber Liquidators (NYSE:LL), investors must feel particularly bullish for what lies ahead in the next chapter of Restoration Hardware.

The headline numbers
Restoration Hardware is a home-improvement retailer but one that operates solely in the luxury space, selling decor, furniture, and complete rooms to a high-end clientele. In many ways, Restoration has become a trend of sorts among the wealthy, which is evident in its fundamentals.

In the company's fiscal 2013 report, comparable-store sales increased 27% which brought total revenue for the year was $1.5 billion. This impressive same store sales growth for FY 2013 was on top of 28% comparable store growth in 2012.

Furthermore, much of Restoration's growth comes from its catalog, in which the company expands its product offerings and makes substantial changes by the season. In this particular segment, sales increased 36% to $732 million -- excluding the additional week in fiscal 2012 -- and that's on top of a 27% increase in 2012.

What's really exciting?
Overall, as you can see, this is a super-fast growing company, one that's profitable as well; adjusted operating income increased 76% in fiscal 2013 to $120.9 million. However, what's most remarkable is that during this time span, Restoration has not added one new store. In fact, from 2012 to 2013, its total store count actually decreased by one to 70, consisting of 62 galleries, five full-line design galleries, and three baby and child galleries. 

Clearly, the fact that Restoration Hardware has been able to grow at such an excessive rate without adding one new gallery is remarkable. But for investors, the fact that Restoration is now set to expand is great news, implying significant future growth. In its report, the company's CEO Gary Freidman had the following to say:

This year, we will open new Galleries in Greenwich [Conn.], Los Angeles, and our first next generation Full Line Design Gallery in Atlanta. Additionally, we are significantly expanding the size our New York Gallery, adding two additional floors to our top performing store in the [c]ompany. We now have signed leases for five next generation Full Line Design Galleries and are in negotiations for an additional 25 locations. 

In case you're not following, that's three new stores, an expansion of its best-performing location, and the company has five more leases already signed. Not to mention a longer-term plan for 25 more locations is in play. Hence, if Restoration can achieve net revenue growth of 30% without store expansion, just think of what it can do with this level of expansion.

Plus, the stock is cheap
Surprisingly, the entire home-improvement industry has underperformed the market in 2014; this despite it being one of the better fundamental-performing spaces in retail.

Home Depot reported earnings in late February; comparable-store sales increased a whopping 4.4% despite the company cutting costs by another 4%. Furthermore, it guided for total sales growth of nearly 5% this year. This is double the growth of Wal-Mart, yet Home Depot's stock has declined nearly 5% this year.

Lumber Liquidators, which is most often compared to Restoration Hardware and which specializes in flooring, has declined more than 10% year to date. Yet it too has seen strong growth, with total revenue growing 22% and comparable sales by 15.6% in its last quarter. While this growth doesn't match Restoration Hardware, it's still impressive in a sluggish retail sector.

Prior to Thursday's earnings report, Restoration Hardware had traded with a loss of 5% this year. Despite finishing 2013 with 55% more revenue -- and faster growth -- than Lumber Liquidators, it trades with a near identical market cap. This disconnect between growth and fundamentals relative to market cap suggests that Restoration Hardware is significantly undervalued.

Final thoughts
The Restoration Hardware forecast is bold, aggressive, and if successful, will create large returns. To conclude, here's one final statement from the CEO regarding his long-term vision for Restoration:

Once our real estate transformation is complete in North America, we believe we will deliver $4 billion to $5 billion in annual sales, achieve [a] mid-teens operating margin...and generate significant free cash flow.

Consider the fact that Home Depot trades at 1.4 times sales and is the quintessential gold standard for home-improvement retail. If Restoration grows to become a $5 billion company, it could carry a market cap of nearly $7 billion, equating to gains of nearly 200% if it carries the same multiple as Home Depot.

Granted, Restoration's margins will be higher and its growth more explosive; therefore, it could possibly trade with even more bullish metrics. Regardless of where it trades in two-to-three years, one thing's for certain: The announcement of expansion takes us into the next chapter of growth, and this is a bullish fact for all longs.

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Brian Nichols owns shares of Restoration Hardware. The Motley Fool recommends Home Depot and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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