RH (RH 1.32%) stock has dropped by a dizzying 58% since reaching its all-time high of over $700 in August 2021. In the last 12 months alone, the share price has fallen by about 21%, more than twice the S&P 500's 9% decline.
It's important to remember that sharp share price declines don't necessarily create value opportunities, however. So let's dig into RH's situation to see if you should heed the market's warning or consider these discounted shares.
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More trouble ahead
With the housing market weakening, RH's sales have contracted. In its fiscal 2022 third quarter, which ended on Oct. 29, revenue dropped by 13.6% year over year to $869.1 million. Management blamed the decline on weaker demand that began at the start of the year. While its product margin increased, its overall gross margin fell by more than 2 percentage points to 48.4%.
The retailer's challenges will likely continue. The housing market has been slowing, with existing home sales dropping for 11 straight months. That's bad news for RH since people tend to buy more of its furniture soon after they purchase homes. Additionally, many economists are predicting a recession in 2023, and that would certainly affect demand for RH's high-end offerings.
In the face of a challenging environment, management has pledged to hold the line on prices even as other retailers have discounted their offerings. Management admits this strategy may result in a short-term loss of market share, but I'm not sure it can win back customers long term. After all, it's always challenging to gain customers back.
Straying from its core business
RH is known for producing luxury goods, particularly furniture. But it also makes other upscale items such as lighting, textiles, and bathware. And it's going to push things further. In attempting to build a broader luxury brand, RH has been expanding into areas unrelated to furnishings such as restaurants, hotels, and even chartered jets and yachts.
While these brand extensions may prove fruitful, it's a risky proposition. After all, it's never easy to build a brand, and RH will have to learn about these other businesses. That may prove a costly experiment with shareholders' money.
A lower valuation, but not a cheap one
Some might look at RH's valuation and see a bargain. The price-to-earnings ratio stands at 12, down from about 25 a year ago. But it's important to understand why it's trading at roughly 50% of the value it was then. RH faces significant challenges from a weaker housing market and a potential recession.
Investors also can't know how the company's new endeavors will pan out. Though RH naturally hopes that some of its core business customers will follow the brand into its additional offerings, hospitality and travel are very different businesses than furniture.
At this point, I would pass on investing in RH stock. While the U.S. may enter a recession and the housing market may weaken further, those will eventually bounce back. But management's willingness to lose customers and enter far-flung fields doesn't stack up for me.
