Shares of RH (RH -0.38%) soared 15.8% in September according to data provided by S&P Global Market Intelligence. The luxury home furnishings retailer is better known by its former name, Restoration Hardware. But the name isn't the only thing that's different about the company. Its margins have been changing, too -- for the better.
The key driver of last month's strong share price performance was RH's impressive set of second-quarter earnings. While sales of $709 million in the quarter were basically flat compared to the same period last year, gross profit margin improved from 41.7% to 46.9%, and operating income margin improved from 14.7% to 19.3%. The end result was a whopping 31% year-over-year increase in operating income in the quarter.
Management trumpeted the results during the earnings release stating that the "emergence of RH as a luxury brand generating luxury margins has arrived years sooner than expected and we now believe we will reach 20% adjusted operating margin in fiscal 2020 with mid single digit revenue growth." Moreover, management held out prospects for further gains on that metric, suggesting it saw a "long term path to 25% adjusted operating margins."
In a nutshell, management's efforts to improve design and quality appear to be resonating with customers and creating additional pricing power for RH. In addition, it appears that RH has been a net beneficiary of the COVID-19 pandemic, as stay-at-home measures have encouraged consumers to spend discretionary income on making their homes more comfortable.
Furthermore, the U.S. housing market has made a relatively robust recovery from the worst of the pandemic. As the chart below illustrates, home prices have risen in 2020 (encouraging high-end homeowners to spend), housing starts have largely rebounded, and housing affordability remains high.
It will be interesting to see if RH's margin growth is going to prove temporary, or whether it will be an ongoing trend as management believes. If margins keep expanding and revenue keeps growing, then analysts and investors will have reason to expect more share price appreciation in the future. Something to look out for.