Restoration Hardware: This Should Really Get Your Attention!

Restoration Hardware's earnings are driving its shares higher in after-hours trading, but in looking at the quarter, investors have more to be excited about than revenue and EPS beats.

Jun 20, 2014 at 9:00AM

Restoration Hardware (NYSE:RH) shares are shooting higher in response to its near flawless quarter. The luxury home-improvement company beat estimates on just about every metric, but for longs and peers like Home Depot (NYSE:HD) and Lowe's (NYSE:LOW), the real excitement lies in something else.


Source: Lalalinen

Now this is impressive!
As every Fool knows, a good investment is not measured by a company's ability to churn out one good quarter, or even two. Instead, the best investments are in companies that deliver over time, or those with a promising future.

Well, Restoration Hardware is telling you exactly what to expect in the future. The company's CEO Gary Friedman said the following in its first quarter report:

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

Obviously, Friedman's goals are ambitious, but so far he's given us no reason for doubt. The company just reported a quarter where net revenue soared 22% compared to last year, and if we look back to the first quarter of 2013, Restoration's revenue grew 38% over the year before it. Furthermore, what's impressive about this growth is that Restoration Hardware did so without the addition of one new store. In fact, it finished the quarter with 69 total stores, down one year over year.

As a result, Restoration Hardware has increased its comparable-store sales by 57% over the last two years, a level of growth not seen by any other company in this space. Also, its earnings per share of $0.18 represents year-over-year growth of 200%, thus illustrating a company that's clicking on all cylinders.

Here comes the expansion!
For a company to grow comparable sales by 57% over a two-year span -- without adding one new store -- it's a very bullish sign for long-term investors. But, what's even more bullish for investors is the expectation during this real estate transformation that Friedman notes.

Specifically, after two years of operating existing stores, and driving revenue per square foot to nearly $300 from below $200, Restoration Hardware is finally prepared to embark on a new chapter of growth.

During the company's fourth quarter, Friedman disclosed that Restoration Hardware would open three new galleries and significantly expand the size of its most popular New York gallery in 2014. He also disclosed that it has signed leases for five new galleries and is negotiating another 25 locations. In other words, Restoration Hardware is about to add new revenue and consumers to its mix of existing store growth.

Therefore, long-term guidance for $4 billion to $5 billion in revenue and an operating margin in the mid-teens might seem too ambitious, but in reality it's likely accurate. Because after all, we don't yet know how much revenue can be created per store seeing as how comparable revenue is still growing at a double-digit clip.

Albeit, with a market capitalization of $3.1 billion, Restoration Hardware is trading at 0.7 times peak sales. If we assume it can create an operating margin of 15%, then it's trading at 4.5 times peak earnings. In comparison, home-improvement juggernauts Home Depot and Lowe's both trade at 20 times earnings, thus implying that there is significant upside potential over the next few years in shares of Restoration Hardware.

Something to consider
The long-term outlook by Friedman combined with its potential profits should really get investors drooling, not its full-year revenue guidance of $1.87 billion. This is a company that still has a lot to gain, and in looking ahead, don't be surprised to see Lowe's or Home Depot show interest.

Neither Lowe's nor Home Depot have a presence in luxury retail, but based on Restoration Hardware, it's an arena within home improvement that is growing quickly with high potential margins. Therefore, it makes perfect sense for either to partner or acquire and then scale the business to become even larger than Friedman expects.

Final thoughts
Obviously, consumers like Restoration Hardware, and judging by its first-quarter and long-term guidance from Friedman, both investors and Lowe's or Home Depot should take notice too. With expansion finally on its way, the best days for Restoration Hardware are likely yet to be seen.

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Brian Nichols owns shares of Restoration Hardware. The Motley Fool recommends Home Depot. 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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