Uncertainty has gripped the stock market thus far in 2022. First, inflation has grown to over 7%, causing the Federal Reserve to turn more hawkish, and many now expect at least four interest rate hikes this year. This has tempered the valuations of many stocks.
Add to this a market at all-time highs and a developing international crisis on the Russia-Ukraine border, and many investors are running for the hills. Other savvy investors see this as an opportunity.
As was the case in late 2018 and March 2020, the most recent major market downturns, such events often present terrific buying opportunities. When these broad market sell-offs happen, long-term investors must identify the stocks and companies that have been caught in the bearish net but remain fundamentally strong. Companies with tremendous cash flow, growing revenue, and visionary management end up on sale.
That is the case with RH (RH -2.02%). This luxury brand of home furnishings doesn't often discount its products, but its stock has been thrown into the bargain bin after falling over 45% from its all-time high.
Don't underestimate management
RH was not always a luxury brand. It was formerly Restoration Hardware, a cash-and-carry retailer of everyday household goods and furniture. The company struggled, and CEO Gary Friedman decided to transform it from top to bottom in 2016. Cash-and-carry was out as the company switched to a direct-to-consumer membership and catalog model, complete with high-end gallery showplaces. This shift was announced in Feb. 2016, and the stock initially plummeted. But since then, an investment of $10,000 would be worth over $100,000 today.
Management's vision was a success, and the company's revenue, cash flows, and profits have grown along with the stock price. Now, it has another focus: international expansion. RH is set to open in the United Kingdom in 2022, followed by new galleries in Paris, Munich, and other regions. Globally, the company sees a market worth $20 billion to $25 billion. This is an aggressive outlook, but management has proved the doubters wrong before.
The results are impressive
In the fiscal 2021 third quarter, RH posted revenue of over $1 billion, an increase of 19% over the same period in 2020. This comes despite significant supply chain headaches related to COVID-19. More impressively, its operating margin increased to 27.1%, an enviable figure for a retailer. The growing revenue and profitability have allowed the company to generate $380 million in free cash flow through the first nine months of the fiscal year.
Because of the recent drop, the stock now trades at an attractive valuation as well. In fact, its price-to-earnings ratio has fallen below pre-pandemic levels as you can see below.
RH stock does have its risks. Not everyone believes in the story, as evidenced by the high percentage of shares sold short. As of Jan. 14, 2022, over 15% of the float was sold short. Cultivating a luxury brand is challenging as consumer tastes can change on a dime. International expansion has serious risks too, especially as COVID continues to wreak havoc on global supply chains, which can stifle RH's results and delay deliveries to customers. Still, the recent results show the company has flourished despite these headwinds.
Is now the time to buy RH?
RH's impressive turnaround story is far from over -- there is an enormous opportunity for the company as it looks abroad. Recent results have shown resilient demand for the company's products, even during a global pandemic. Operating margins are impressive, revenue is growing, and the company is generating solid cash flows.
If management continues to execute well, this investment could provide outsized returns for long-term investors.