Investors are warming back up to RH (RH 5.62%) stock. The high-end furnishings giant's shares jumped nearly 50% over the past three months despite the fact that sales are down and the industry remains in price-cutting mode.
Is Wall Street right to sound the all-clear signal for this stock, or should investors wait for more clarity around consumer spending patterns before buying? Let's take a closer look.
The latest results
RH's latest results show that the furniture seller is making the best out of a bad situation. Sales fell to $869 million in the most recent quarter from $1 billion a year earlier. Revenue is down modestly over the last three full quarters, too.
That decline isn't so bad when you consider the context. The home furnishings industry contracted sharply in recent months and is going up against huge gains from a year ago. Wayfair reported a 23% drop in active customers this past quarter as order volumes fell by about the same amount.
RH's sales are up 28% compared to the pre-pandemic Q3 period three years ago, but the selling environment is weak right now.
Blazing its own path
RH has decided against cutting prices to keep inventory moving during this demand slowdown. That strategy comes with some big risks, including the potential for inventory write-downs or market share losses.
The payoff is that RH is still generating robust profits and positive cash flow. Adjusted operating margin landed at over 20% of sales, and the company remains far more profitable than industry rivals like Wayfair and Target.
RH Operating Margin (TTM) data by YCharts
Management also is betting that the move will protect RH's luxury status when the eventual rebound happens. "[W]e believe there is certain long-term risk of brand erosion ... for those who choose the promotional path," the company said in an early December letter to shareholders.
Looking ahead
Time will tell whether RH is right to take this full-price approach. Investors will want to watch inventory levels for signs that the business is risking more significant write-downs into late 2023.
But for now, the finances look strong. RH generated positive cash flow last quarter and is sitting on over $2 billion of cash compared to less than $400 million of net debt.
Yes, the stock seems richly valued at 2.6 times sales compared to 0.8 for Target and 0.6 for Wayfair. But RH's valuation had been over 6 times sales through much of 2021, when sales and profits were soaring.
Investors can't expect a repeat of those unusually strong results, which were powered by rising incomes and intense demand for home furnishings. But the stock deserves a premium for its market-leading profitability and strong cash position.
Cautious investors might want to wait for clear signs of demand stabilization before buying RH. However, if you're not afraid of the short-term risk of a recession ahead, consider adding this stock to your watch list.
RH performed well during the pandemic spike and is maintaining solid momentum during the current growth hangover. These wins suggest it can generate strong returns through a wide range of selling conditions, and that's a valuable trait to have in your portfolio.
