Wall Street is down on most retailing stocks right now and is practically ignoring companies in the home furnishings space. Investors are concerned about sales pressure on retailers as consumer spending patterns slow. And furniture companies are more exposed to risks from a recession than peers that sell more consumer staples products, like groceries.
Yet downturns are regular parts of the economic cycle, and they don't threaten the long-term growth outlook for a business like RH (RH 2.28%). Smart investors know that the luxury home furnishings specialist can endure weaker demand without taking too big a hit to its business.
It's a challenging market
That said, RH isn't well insulated from the short-term challenges of weaker consumer spending. Sales in the most recent quarter were down nearly 20% to $800 million. That decline was partly due to soaring results a year ago, but management also said in a letter to shareholders that demand fell due to industrywide issues, including slowing home sales and rising interest rates.
Things might get a bit worse before they improve. RH is projecting that sales will fall again in the fiscal third-quarter period while profitability shrinks. Management says trends will then start rebounding, especially around profit margins, beginning in the fourth quarter. "We continue to expect our business trends to inflect in the second half of this year," they told investors in late July.
Industry-leading margins
One of the best reasons that smart investors like this business is its unusually high profit margins. Operating income has been over 20% of sales in each of the last two fiscal years. Compare that result to Wayfair (W 2.08%), which only briefly touched single-digit profit margin during the high-growth phases of the pandemic.
W Operating Margin (TTM) data by YCharts
Investors can expect RH to fall short of that level in 2023, but not by much. Operating margin is on pace to land at about 15% this fiscal year, according to management's latest forecast. That success is a testament to RH's efficient business model and its focus on the luxury niche within the wider home furnishings industry.
The stock price
RH's stock price has declined to the point that smart investors are starting to notice. Shares today are trading at less than 2 times annual sales, down from the pandemic peak valuation of 6 times sales. Similarly, you can buy RH stock for less than 19 times earnings, compared to 32 times earnings earlier in the year.
Sure, the short-term prospects for this business are cloudy. The stock will likely remain volatile as Wall Street reacts to every shift in the likelihood of a recession striking the U.S. economy over the next several quarters. Shareholders have already caught a glimpse of these stock price swings. RH stock has been up by over 40% at times this year and has also spent time in negative territory.
If you're OK with those short-term risks, you should consider adding this stock to your watchlist. RH is a highly profitable business with attractive growth prospects in both the U.S and in its international markets.
The stock's lower valuation should support solid long-term returns for shareholders, notwithstanding any upcoming recession. Your greatest asset as an investor is the ability to see past those quarter-to-quarter swings in operating results to focus on the bigger picture. The good news is that this picture is decidedly positive for RH.
