RH Really Needed This Power Quarter

The business of selling high-end furniture can be a bit hit or miss at times. A $7,000 couch is the sort of discretionary purchase that a person is much more likely to postpone if he or she isn't feeling flush with cash. So emotional headwinds really took a bite out of RH (RH 1.32%), the former Restoration Hardware, back in its fiscal 2018 fourth quarter, after the stock market's precipitous tumble left its target customers poorer. But the fiscal first-quarter 2019 report it dropped Wednesday showed what a difference a few months can make.

In this segment of the MarketFoolery podcast, host Chris Hill and MFAM Funds' Bill Barker dig into the factors that helped RH rebound -- its exposure to conditions in the stock market, low interest rates, and its relative immunity from the Trump administration's tariffs -- as well as its investment thesis from here.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on June 13, 2019.

Chris Hill: You know what? When that day comes, I'm going to be shopping at Lululemon because I know they can actually provide good apparel. Let's move on to RH, which is better known as Restoration Hardware. First quarter, they needed this quarter. Restoration Hardware put up some strong profits. They raised guidance for the full fiscal year. The stock is up 21%. And as they said, they needed it, because even with this rise today, it's still down year to date, and really over the past 12 months.

Bill Barker: They are correlated -- I may come back and address whether they're better known as Restoration Hardware, and why they got away from that name to go to RH. I think that naming has a thread through today's episode of all these stories. In disclosing their last quarterly report and lowering guidance for the year, RH was affected, seemingly, because of the highly discretionary nature of purchasing anything at Restoration Hardware, which is not competing on price. To be affected by, if not the economy, the stock market going into the fourth quarter, when the stock market last year was very weak. That would have affected their biggest quarter. They were projecting ahead and seeing discretionary spending for their end, of the furniture, under attack. And it's been a better quarter since three months ago. They've had a better quarter in their results. Now they're able to project ahead. We'll see, if the market goes down 15%, whether they're making another adjustment. Not that that's the only element of what affects the upper middle class or upper class, the people who are most likely to be shopping at Restoration Hardware. But the market does affect, at least in the short-term, some discretionary spend.

Hill: But one of the things we've talked about on this show, and has been covered ad nauseam across financial media, is the ripple effect of tariffs. Part of the way RH was able to put up this good quarter is because, as they said, they selectively raised prices on different items because of the effect of tariffs. I looked at that and thought, yeah, you know why? Because they can. Because the people who are going in to buy an expensive sofa, if it's 8% more expensive because of tariffs, they're not going to bat an eye at that, because they're already shelling out a good amount of money. It's not to say that they can do it across the board. Clearly, they haven't, because they realize they can't do it across the board. But I think they have pricing power. At least in this one quarter, they showed that they know how to use it smartly.

Barker: Well, they have it. What that in part depends on is the other end of the equation, the people having the money to spend. Another thing that has helped them recently is the decline in interest rates. You've got a lot of purchasing being made in conjunction with people moving. House sales are going to do better in a low interest rate environment. We've been in a generally low interest rate environment, but we had interest rates going up, mortgage rates going up, going into the end of last year or some of the early months this year. Now things have come down. You're seeing this, of course, in refinancing. The numbers in the most recent couple of weeks being very good. If people have more money to spend on fixing up their houses and furnishing their houses because they are spending less money on their mortgage, that's all the good for RH and other companies in the space. But remember that when interest rates go back up, as they someday will, that will come at the expense of some of the discretionary spend around housing.

Hill: Let's go back to Lululemon for a second. We've got Lululemon shares that are, as you said, hovering around an all-time high. We have RH, which is up big today, but still down more than 15% or so from its 52-week high, even with this rise that we're seeing today. Does one of these look more attractive to you than the other?

Barker: I would say that strictly based on valuation, I'd be more confident in Lululemon's ability to compound the growth of the company. That is fully priced in, I would say, with the price of the stock. RH, which is up $20 today, is still about 30% off of its high back in August of last year. In a good economy, they've got more room to grow. I think it depends on what you're betting on with interest rates. If you can tell me where interest rates are going, I can answer you that question correctly. Tell me which way interest rates are going!

Hill: Alas, I cannot do that.

Barker: I think that Lululemon, where it is right now, higher floor, lower ceiling. From today's price point, I think RH, more variable. There's a higher high if a couple things go right for it. The things that can go right for Lululemon are going right, have been going right. They're getting credit for that, as they deserve to. But how much more can go right is going to take time, whereas you see today, 20% up, RH is a little bit better than we were expecting, pointing to a better year ahead, and they're making up a lot of the ground that they lost.