Why RH Stock Is Hitting an All-Time High

In this episode of MarketFoolery, host Chris Hill chats with analyst Maria Gallagher about the latest news, headlines, and earnings reports from Wall Street. The pair discuss RH's (RH 1.32%) monster second quarter, as well as the departing CEO of a top bank and his successor. They also answer listeners' questions on the earnings prospects of a mortgage company.

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This video was recorded on Sept. 10, 2020.

Chris Hill: It's Thursday, Sept. 10. Welcome to MarketFoolery. I'm Chris Hill, with me today, first time in a long time, it's Maria Gallagher. Good to see you.

Maria Gallagher: Good to see you too, Chris.

Hill: We are going to talk about a recent IPO, we have got a high-profile CEO change, but we're going to start today with RH, the company formerly known as Restoration Hardware. RH had a monster second quarter, profits much higher than expected, strong overall sales. And shares of [laughs] RH are up more than 22% today and the stock is hitting an all-time high.

Gallagher: I think RH is kind of interesting, because a lot of what we're talking about right now is people will look at revenue growth; if you look at Zoom's growth in the quarter or all of these different companies. And RH only increased revenue less than 1%, but the really impressive thing was, like you said, Chris, the increase in their gross margin, their operating margin, and their net margin, and their earnings per share. So, I think it's kind of a different response than we've been seeing a lot for these high-growth tech stocks, this is more of a company that's showing they have a lot of pricing power and they're growing in a way that we haven't seen very a lot recently.

Hill: Yeah, RH is [laughs] for anyone who's ever been in a Restoration Hardware, you know, it's one of those stores you walk in, it's like, well, it's clearly nice stuff, it's quality merchandise. Some of it is exceptionally pricey. But I think this probably goes along with the narrative, in the same direction, as the narrative that we've seen in the last six months with companies like Wayfair, and Home Depot, and Lowe's, where more people are looking around the homes that they are trapped in and saying, all right, if I'm not going to go on a big vacation, I'm going to spend money improving this place that I live in.

Gallagher: Yeah. And that was called out in the shareholder letter for this quarter. They talk about the elevated level of spending in the home. So, yeah, the booming real estate activity, accelerated shift from moving to a larger home, a lot of people are leaving the cities, moving to the suburbs, and then uptick in homebuilding, trying to renovate, to make sure their workplace is the best place they can have possible. And because we were talking about it, I did spend a good chunk of my morning on the Restoration Hardware lookbook website, and I now want to buy a $5,000 couch.

Hill: [laughs] Well, I mean, look, I'd like to buy a $5,000 couch, but it costs $5,000 and that's why I'm just going to stick with the couch that I have.

Gallagher: Yeah, the last couch I got was on Craigslist for $100.

Hill: For the growth that this stock has seen, and look, we've seen a lot of stocks, you mentioned Zoom, Zoom is in this category. Even with the recent drop over the past week or so, Tesla, which started out the year at around $85/share is still around, I don't know, this morning before the market opened it was close to $390. Restoration Hardware is up roughly 5X in value since late March, I know I'm cherry-picking the bottom, but it's a reminder that it's not just the sexy tech companies that can have these kinds of returns. Where I'm going with this, Maria, is that for all of this growth, Restoration Hardware -- and I can't call it RH, I'm sorry -- this company is still a $7.5 billion company. This is not huge. Do you think this is still an acquisition target? Because it seems like the sort of thing, in the same way that people have said about Wayfair, despite Wayfair's growth, you know, someone could still come in and make them an offer. Restoration Hardware is not a very big company, and it appears to be very well run, and as you said, they're really doing good things with their margins.

Gallagher: I think it's a possibility. So, Wayfair is about $24 billion right now. I think it has a niche within the luxury market, and in their earnings call they also talk about how they have elevated their shift to a luxury brand with luxury margins at a higher pace than they anticipated. And so, I think that if you're looking to expand into this niche, it would be a really interesting acquisition target for them. They do, in their letter, also talk about all of their long-term growth plans, and some of them are kind of lofty. They're planning to open hotels. They have a luxury yacht called the RH3, that is available for charter in the Caribbean and the Mediterranean. So, they have pretty lofty goals of what they want to be. So, I wonder if they don't think they want to be acquired, but I think if I was a company looking to grow into that luxury niche, this would be something I would be considering.

Hill: That will be interesting to see, because they've done a good job of spreading their brand in smart ways aimed at new parents, aimed at people who are looking specifically for furnishings for a beach house or a ski lodge, that sort of thing. So, the move into hotels, we'll see how that goes. But they've earned the right to make that mistake, if it ends up being a mistake.

Let's move on to the big banks. Michael Corbat started working at Citigroup in 1983. He has spent the last eight years as the CEO. Citi announced today that Corbat is going to be stepping down in February. Taking his spot in the corner office is Jane Fraser. And this makes Fraser the first female CEO of a major U.S. bank. Obviously, a history-making day for Citi. And you look at her experience, on paper, Maria, it really seems [laughs] like Citi picked the right person.

Gallagher: Yeah. She has a really impressive background. She has her MBA from Harvard, she has her master's in econ from Cambridge, she worked at McKinsey, she joined Citigroup in 2004. She led the consumer and commercial banking division. She was the co-CEO of Latin America. And as of last year, she became the president and the CEO of the Consumer Banking Industry. And so, I think that she is just the most qualified person to take the job. And I think it's wonderful that she's a woman, but I think that's also something we should focus on, is that she's just really well experienced. She's had a great tenure at the company, she's done really wonderful things. And as of now, only 31 out of the 500 S&P 500 companies are led by a woman. So, to join that rank is very exciting, and she's clearly, I think, the best person for the job.

Hill: Michael Corbat is, you know, from everything I've read, he's someone who is well liked on Wall Street. The fact that he was at the same bank for nearly 40 years, I think speaks well of him. But if you are a shareholder of Citi, you can absolutely, and fairly, [laughs] look at Michael Corbat and the fact that in the eight years he's been the CEO the stock has basically returned about 40%, over an eight-year period it's increased by 40%. And I think you can wish Michael Corbat well and very much look forward to the Fraser era, because from a stock performance standpoint, she could be a real winner for shareholders.

Gallagher: I think definitely. I think she'll come in, and she'll come in swinging, she'll come in ready to go. She's been there for long enough; she doesn't need to be onboarded into the way the company works. She's been there for 16 years. She has a long history of working in different divisions, so getting it to be a cohesive unit that really starts out to outperform. I'm excited to see what she does.

Hill: Quick programming note, on Motley Fool Money this weekend our guest is Robert Brokamp. The Motley Fool's resident retirement expert. We're going to be talking about Dividend Aristocrats and portfolio allocation. And National 401(k) Day, which I didn't realize is a thing, but it actually is a thing, so we're going to talk about that as well. Our email address is [email protected]. Once again, [email protected]. Write us a note, would you? We're lonely over here in the pandemic.

A question from Jim in Iowa who writes, "I know Rocket Companies has only been public for a month. That said, the housing market is stronger than I thought it would be, and I have to believe Rocket is a company that would benefit. Do you have any thoughts?"

For those who are unfamiliar with Rocket Companies, this is the parent company of Rocket Mortgage, which probably people are very familiar with, if for no other reason than the amount of advertising they do.

Gallagher: Yeah. So, Rocket Companies is a pretty interesting business model. So, what they do is they originate and underwrite the loans and then they bundle the loans and they sell them to government-backed entities and then they retain the servicing rights for those loans which they get money from selling the loans and then they get money from servicing their loans, but they are only actually holding on to the loans or holding on to that risk for about three weeks before they sell them. So, it's a really interesting way to get exposure into this type of market without the risk of the default on those loans.

And since they're selling them to government-backed entities like Fannie Mae and Freddie Mac, and HUD [Department of Housing and Urban Development], they're generally pretty steady entities to be buying them. So, it's less risky than I would think going into the mortgage market.

Hill: It really is one of those businesses, and we've seen this certainly in the car-buying process as well, it's one of those businesses that is, for anyone who can make it easier, [laughs] there are profits to be had. And it really does seem like, you know, to this point anyway, they've done a great job with that.

Gallagher: Yeah. And if you go to their website, I also went to their website to try and see if I am eligible for a mortgage, I'm not, [laughs] but their website, their interface is really easy to use, it kind of reminds me of -- I don't know how you pay your taxes, Chris, but I use TurboTax, it kind of reminds me about the easy interface, that TurboTax fills out a lot of the stuff for you, talks to you at a level in which you understand. And as more and more people are shifting to buying things online and not necessarily wanting to go to a bank to underwrite the loans, more and more millennials are buying their first houses, I think that Rocket Mortgage will be a real leader, more than it already is.

Hill: They're not talking about starting their own hotel chain, are they?

Gallagher: I don't think so, but maybe the yacht. I think the yacht was most surprising to me for RH. I was looking into it.

Hill: Maria Gallagher, always good talking to you, don't be a stranger.

Gallagher: Thank you so much for having me.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill, thanks for listening, we'll see you on Monday.