Please ensure Javascript is enabled for purposes of website accessibility

Is Restoration Hardware (RH) Stock a Buy?

By Jon Quast - May 17, 2020 at 12:32PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Stores are closed, and the economy is faltering, but RH has a $20 billion opportunity.

Luxury furniture company RH (RH -4.18%), formerly known as Restoration Hardware, is closed for business at its 83 retail locations. Many of the company's most important stores are located in major U.S. cities -- areas hit hardest by the COVID-19 pandemic. E-commerce and catalog orders are still an option for consumers, but RH is primarily a physical retail business.

Based on stock performance, it's clear investors are betting on the success of e-commerce furniture companies in lieu of traditional brick-and-mortar retailers like RH. Just consider the year-to-date returns of RH compared to Overstock and Wayfair.

RH Chart

Data by YCharts.

It's possible this trading disparity presents an opportunity. Substantially down in 2020, is RH stock a buy right now?

Here's what to like long term

RH swims against the current. While most businesses try to attract broad audiences, RH firmly planted its flag as a luxury (pricey) furniture retailer. It has foregone conventional wisdom to limit its physical stores and turned its locations into gaudy, sprawling showrooms. And rather than attract consumers with special promotions, it offers paid memberships for those looking for everyday discounts.

The core furniture business gives investors top-line gains from comparable-sales growth and the addition of new retail locations. But more importantly, RH's management team is adept at finding ways for superior earnings growth. One current example is the company's home-delivery service. In the past year, it's taken full control of the service, ensuring goods arrive in mint condition. This creates a happier customer and requires fewer returns. And RH estimates it will save $15 million to $20 million annually as a result, growing earnings on the same revenue.

Additionally, RH is diving into hospitality now while guarding its core business. The company has six restaurants inside its furniture showrooms and is slated to open its first guesthouse in 2020. The restaurants are extremely popular, which is good news for shareholders. However, they could be making even more money, yet management isn't pursuing this option. Here's why that's good.

In RH's earnings call for the first quarter of fiscal 2019, management said its restaurants are highly requested event venues. However, the restaurants' purpose is to be an integrated part of the core furniture business. RH believes that if it offered these spaces for events, it would detract from the experience it's offering. So while it could squeeze more revenue out of restaurants, it might come at the expense of its furniture business -- a path management isn't willing to walk. This remains a furniture company.

And that business has room for substantial international growth long term. Right now, RH management sees a fragmented luxury market in Europe and has identified five to seven prime locations to begin international expansion in the next couple of years. It believes RH could become a $20 billion business because of the opportunity. For perspective, the company has generated $2.6 billion in trailing twelve-month revenue. 

Growing its physical footprint would be expensive, but RH expands in a lean way. It uses a sale-leaseback model, selling its properties to landlords and leasing them back on 40-year contracts. In the end, there's little upfront cost for RH, increasing both profitability and accelerating its new property payback.

A living room arrangement from RH with sofa, coffee table, chandelier, and other decor.

Image source: Restoration Hardware.

What to be concerned about now

It's not obvious, but stock market volatility is problematic for RH's customer base. In the earnings call from the first quarter of fiscal 2019, CEO Gary Friedman said luxury furniture consumers are wealthy individuals who likely have a large percentage of their net worth in the stock market. In a downturn, their net worth falls, which may influence them to postpone purchases. Granted, RH is closed right now anyway. But if the market stays volatile, it could be a headwind for the business.

Furthermore, a bad economy is bad in general for consumer-discretionary brands -- especially luxury retailers like RH.

But I believe e-commerce is the biggest threat to RH long term. Both Wayfair and Overstock recently updated investors with quarter-to-date results, showing 90% and 130% year-over-year revenue growth, respectively. Yes, RH is targeting an entirely different customer. However, it's "all in" on physical retail. If the coronavirus drives furniture e-commerce adoption among affluent consumers (like it has for others), that would be devastating for RH.

Is it a buy?

I like RH and believe solid past execution coupled with a growing international opportunity will make this a long-term winner. However, I acknowledge the business will remain challenged in the near term, without any way of knowing how long locations will remain closed. With no clear upside catalyst in the near term, investors might consider buying this stock in thirds -- one third now and the other two thirds if the stock goes down or once there's clarity for RH getting back to normal operating conditions.

Jon Quast has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Wayfair. The Motley Fool recommends RH. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

RH Stock Quote
RH
RH
$298.30 (-4.18%) $-13.01
Overstock.com, Inc. Stock Quote
Overstock.com, Inc.
OSTK
$28.48 (-8.07%) $-2.50
Wayfair Inc. Stock Quote
Wayfair Inc.
W
$57.01 (-20.09%) $-14.33

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
397%
 
S&P 500 Returns
128%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/20/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.