Investors are avoiding many retailing stocks right now, and they're practically running from those businesses that cater to home furnishings shoppers. Companies like Wayfair, Target, and Home Depot have seen their share prices slump in recent months on fears about tougher selling conditions into 2024.
The sell-off in RH (RH 2.28%), which focuses on luxury home furnishings, seems particularly overdone. Here are a few reasons to consider buying this stock after its decline in recent weeks.
1. Building momentum
The company reported just $800 million of revenue in the most recent quarter, translating into a painful 20% drop from last year's $1 billion haul. Yet investors shouldn't overreact to that slump.
The second-quarter result was better than management had predicted, however. Executives said in May that sales would land between $765 million and $775 million. And they've now modestly raised their 2023 forecast in each of the last two quarters.
Better yet, RH is on track to return to growth in the current quarter after several quarters of declines. Most Wall Street analysts expect sales to rise in the next fiscal year as well, suggesting the worst of the growth hangover is now behind this business.
2. Solid finances
RH is in an excellent financial position today. Management took on some debt before interest rates surged, providing valuable flexibility through the recent downturn. But the company hasn't needed to tap into these funds. Cost cuts and efficient inventory management helped it generate $250 million of operating cash flow in the first half of 2023, up from $193 million a year earlier.
RH also remains highly profitable despite its temporarily shrinking sales base. Operating profit margin is near 20% of sales, well ahead of peers including Target and Wayfair.
It's great news for the business that RH is expecting profit margin to remain above 15% of sales in an environment that management describes as "challenging" for the luxury furnishings market. While volatility is likely over the next few quarters, this success implies that RH can return to an above-20% margin once the housing market begins recovering.
3. The stock price
Investors are getting a chance to buy RH at a discount that reflects Wall Street's excess focus on the short term. Shares are trading at below 2 times annual sales, down from 3 times sales in early September. The same trend holds for the price-to-earnings (P/E) ratio, which has declined from 32 to 19.
Sure, RH's growth prospects are weak this year and could be further pressured by a housing market slump in 2024. But cyclical downturns are a normal part of this industry, and the retailer has the financial resources to continue investing in growth while many rivals are forced to focus on saving cash.
The main risk to the bullish thesis is that RH's sales trends worsen to the point that management has to reduce its earnings outlook. Falling market share would also cause concern if the company's latest product launches fail to resonate with shoppers.
Yet there's no indication that either of these problems exist for RH right now. Instead, the company is raising its sales and earnings targets and refreshing major parts of its catalog. RH could be a compelling buy opportunity for investors who don't mind the risks associated with retail stock volatility.
