RH (RH 1.99%) CEO Gary Friedman has never been one to mince words, and he didn't let investors down in the latest earnings report. Friedman said, "the housing market has collapsed" on the recent earnings call, and the company's results show that it has quickly gone from enjoying pandemic-era tailwinds to suffering the opposite. Higher mortgage rates have soured demand in the housing market.
Revenue in the quarter fell 14% to $869 million, though that topped the company's own guidance and the analyst consensus of $838.1 million. On the bottom line, the company also delivered stronger-than-expected profitability, with an adjusted operating margin of 20.8%. Though that was down from 27.7% in the year-ago quarter, Friedman said the company resisted the kind of discounting that has become rife across the industry, choosing to accept the short-term risk of market-share loss in exchange for avoiding the long-term risk of brand erosion.
RH's adjusted earnings per share slipped from $7.03 to $5.67, but that beat the average estimate at $4.70. Finally, it tweaked its full-year guidance, slightly lowering its revenue-growth forecast to 3.5%-4.5% from 3.5%-5.5%, but it raised its adjusted operating margin outlook of 21.5%-22%, up from 21%-21.5%.
With revenue now falling by double digits, Friedman was sober about the challenges ahead for the company. He said in the shareholder letter, "We expect our business trends will continue to deteriorate as a result of accelerating weakness in the housing market over the next several quarters and possibly longer, due to the Federal Reserve's anticipated monetary policy and the cycling of record COVID-driven sales and backlog reductions." However, there are reasons to expect better times for the stock.
Image source: Getty Images.
The long-term focus
Despite the weakness in the housing market and therefore the high-end home furnishings market that is the company's focus, Friedman and his management team are stepping on the gas when it comes to pursue his vision of "scaling taste" and building the world's most admired brand.
In addition to introducing new sub-brands, like RH Couture, RH Bespoke, and RH Color, the company also aims to open its design galleries in every major market, driving $20 billion to $25 billion in revenue globally, or six times what the company's sales are today. To drive the RH Couture and RH Bespoke businesses, the company made a pair of acquisitions of to-the-trade custom-furniture companies -- Dmitry & Co. and Jeup -- in the quarter. Friedman envisions a comprehensive design business that sells fully furnished luxury homes, dubbed RH Residences, in addition to its core furnishings business.
RH has also expanded into experiences, with two private jets and a yacht available to charter, and restaurants and hotels coming online. It even plans to launch its own streaming service focused on architecture and design, and recently hired the former Editor-in-Chief of Architectural Digest, Margaret Russell, to run the new RH Media business.
The company is also planning to launch in Europe this spring with several openings in European markets through 2025, unlocking yet another valuable revenue stream.
The valuation disconnect
For a company with this kind of growth and track record of success, you would typically expect shares to be expensive. However, RH trades at a price-to-earnings ratio of just 9, a valuation generally assigned to low-growth or no-growth stocks. There's a clear reason for that, and Friedman acknowledged it himself, saying, "I've never been more excited about our future and I've never been more uncertain about the present."
The present is indeed uncertain, and as long as interest rates are rising and home prices fall, RH's quarterly performance is likely to remain challenging. Investors should keep their eyes on the long-term vision.
Friedman has already proven himself on more than one occasion, reinventing the company formerly known as Restoration Hardware and pivoting to a membership model. This temporarily crushed the stock before the move delivered strong growth. Since RH's initial public offering (IPO) a decade ago, the stock is up more than 700%, even including the sharp sell-off over the last year. This is a credit to Friedman's leadership.
Not all of Friedman's ideas will pay off, but they don't all need to for the stock to be a winner. Driving a comprehensive luxury vision for the company is a clever way to leverage its brand equity with its membership-based clientele, and no other luxury brand is as strong in home furnishings as RH. Building an extended luxury brand around the home makes perfect business sense for the company.
At the current valuation, the stock doesn't even need those emerging businesses to deliver, as RH's results should turn around when the housing market comes back. However, if the new businesses -- like restaurants, guesthouses and media -- do take off, the stock could explode from here.
