Berkshire Hathaway's (NYSE: BRK.A)(NYSE: BRK.B) Warren Buffett has quite an eye for quality. The company's $321 billion investment portfolio is loaded with dozens of some of the best businesses in the world.
One of those businesses is RH (RH 1.99%), previously known as Restoration Hardware. Let's dive deeper into why Berkshire Hathaway holds a 10.7% equity stake (or nearly 2.4 million shares) in this business, and why it could be a no-brainer buy for value investors.
Selling luxury products is a lucrative business strategy
Brand quality matters greatly to Berkshire Hathaway: Customers are much more inclined to fork over their hard-earned money for a product when the brand inspires confidence in them, which is especially the case with luxury brands. And few companies can appeal to an affluent clientele as well as home-furnishings company RH.
That's because RH differentiates itself from the competition with products made by world-class designers and manufacturers in limited quantities. That creates the perception of exclusivity in the minds of its customers, which is why customers don't mind paying more for its products than they would from competitors such as Wayfair and Target. Such a competitive advantage also explains how the company's trailing-12-month 22.3% operating margin was well above Target and Wayfair's respective operating margins of 4.4% and negative 9.5%.
As a mid-cap company with a $6.3 billion market capitalization, RH has yet to reach its full potential. The company had just 121 locations as of last October, and that could easily grow several times over. That's because RH predominantly operates in the U.S., with a handful of locations in Canada and the U.K. The company expects that it will be opening locations in iconic European cities such as Milan, Madrid, Munich, Brussels, and Paris within the next two years.
That move will significantly expand RH's total addressable market, which could provide the growth needed to help it blossom into a large-cap business. And that could lead to significant upside in the share price over the long haul, which is something Berkshire Hathaway would undoubtedly like to see, since RH doesn't currently pay a dividend.
The balance sheet is a financial fortress
RH has the financial capability to fund its international expansion efforts, which is demonstrated by its strong financial position. The company's net debt is expected to come in at $629 million in 2023. Measured against the $906 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) that the company is projected to generate in 2023, this is a net debt-to-EBITDA ratio of just 0.7. That's a reasonable enough leverage ratio that the company will have no issue borrowing more funds in the future as it continues to grow in size and scale.
It's not too late to buy the stock
With the stock trading 18% above its 52-week low share price of $207 and 33% below its 52-week high of $391, now could be a good time to buy. The company's forward price-to-earnings (P/E) ratio of 15.3 is less than the specialty retail industry's average forward P/E ratio of 16.3.
This modest valuation explains why analysts have an average 12-month share price target of $325, which would be a 25% upside from the current $260 share price. That's why RH is arguably a solid Buffett-owned value stock worth considering for your portfolio.
