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RH Is Aiming to Match Warren Buffett's Greatness

By Dan Caplinger – Dec 4, 2018 at 9:39AM

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So far, the luxury home furnishings retailer's results are living up to its lofty goals.

Every company wants to become a giant in its field. But it takes a combination of determination and pure ambition to seek to join the ranks of the greatest businesses of all time. Those who've followed luxury home furnishings retailer RH (RH -7.38%) won't be surprised to see Gary Friedman, its flamboyant CEO, show those characteristics in comparing his company's aspirations to follow in the footsteps of LVMH, Apple, and even Berkshire Hathaway (BRK.A -0.42%) (BRK.B -0.45%).

Coming into Monday's fiscal third-quarter financial report, RH investors fully expected that the retailer would continue to show the growth that it's achieved regularly since it began its latest efforts to transform its business. Yet the magnitude of RH's growth was a pleasant surprise, and the company's optimism for its future has shareholders more excited than ever about RH's prospects for the remainder of the year and beyond.

Lounge chair and ottoman with a lamp and bookcase all in gray and gold.

Image source: RH.

Another surge for RH

RH's third-quarter results showed that the company's self-restoration continued to gain momentum. Revenue was higher by 7% year over year at $636.6 million, which exactly matched what most of those following the stock had expected to see. Just as we've seen in recent quarters, though, adjusted net income skyrocketed, rising 92% to $46.8 million and resulting in adjusted earnings of $1.73 per share. That crushed the $1.27-per-share consensus figure among investors.

Fundamentals remained favorable at RH. Comparable brand revenues rose 4%, even though the figure encountered 2.5 percentage points of downward pressure due to inventory reduction in last year's fiscal third quarter. Strong sales in RH's full-price stores were instrumental in helping the company's top line and were remarkable in that tariff-related issues cost the company about a percentage point of comps and overall revenue growth.

RH's emphasis on cost management was once again evident. Operating margin jumped more than two percentage points on an adjusted basis to 10.3%, and the retailer attributed much of the gain to higher-margin sales at its outlet locations. Once again, lower income tax rates also helped RH's bottom line, with the company paying less in tax despite making half again as much in pretax income.

CEO Gary Friedman was quite pleased with the company's performance. Friedman said, "Our record this quarter results demonstrated the strength of the RH brand, our commitment to earnings growth, the power of our new business model, and our continued success revolutionizing physical retailing." The CEO also emphasized management's discipline in sticking to the segments of the luxury retail market that have the greatest potential to maximize profit.

High hopes for RH

Friedman also went to great lengths in discussing three companies he admires highly and the ways in which RH's attempts to emulate those companies are paying off:

Like LVMH, we are building a luxury platform, and in a similar fashion, we are beginning to demonstrate that we too can be rewarded with luxury brand margins that are double those of competitors targeting broader markets. ... Similar to Apple, we are designing a seamlessly integrated ecosystem of businesses that all amplify and render our brand and each other more valuable -- where the whole becomes more valuable than the parts. ... Akin to Berkshire Hathaway, we are building a business that is capital efficient, generates significant free cash flow, enjoys a low cost of capital, and is developing a culture relentlessly focused on [return on invested capital] and capital allocation.

Perhaps most insightful was Friedman's extended discussion of RH's decision to carry out the massive stock buybacks that cut its outstanding share count in half. Pointing to Berkshire's making winning investments in the aftermath of the financial crisis, the CEO said, "That is precisely why we took advantage of the favorable capital markets in 2014 and 2015," raising $650 million in a bond offering that it later used to repurchase shares.

Regardless of whether RH will ever match Buffett's greatness, the company does believe that the remainder of this year will go better than it had previously expected. The company again raised its guidance, with new earnings expectations of $8.33 to $8.47 per share representing about a $0.72 to $0.98 per share increase from its previous range. RH also pushed its revenue guidance slightly higher to a range of $2.519 billion to $2.529 billion, with sales expectations of $680 million to $690 million in the fourth quarter representing a $5 million to $15 million increase from earlier guidance for the quarter. Earnings for the fourth quarter should be between $2.75 and $2.90 per share, up from the $2.33 to $2.54 per share previously projected.

RH investors were ecstatic about the news, and the stock price soared more than 20% in premarket trading Tuesday morning following the late-Monday announcement. If RH can make good on its ambitious plans, then even Warren Buffett might end up impressed with the results -- regardless of whether Berkshire ever ends up investing a penny in the luxury retailer.

Dan Caplinger owns shares of Apple and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends RH. The Motley Fool has a disclosure policy.

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