Despite recent volatility, the markets are still up so far this year. The S&P 500 has risen by some 14% in 2023, even with the recent downdraft. But not all stocks have benefited. RH (RH 2.28%), primarily known for selling upscale furniture, has been a laggard. Its share price has dropped by more than 20% since the start of the year.
Does this dip represent a buying opportunity, or is it a sign of larger problems? Let's find out.
Image source: Getty Images.
Housing market
Catering to a higher-income customer, RH is affected by the overall economy and housing market. That helped the company's results when low mortgage rates fueled homebuying. But that's changing.
Mortgage rates have been climbing. The 30-year fixed rate was recently 7.76%, up from below 3% at the end of 2020. When rates were low, that stimulated a lot of homebuying and, in turn, demand for RH's products. For the company's fiscal 2021, which ended on Jan. 29, 2022, revenue came to $3.8 billion, about 42% higher than in its fiscal 2019. During those two years, operating income jumped from $362.8 million to $927.2 million.
But now homebuying has slowed. As a result, RH's fiscal second-quarter revenue dropped by more than 19% to $800 million, and its net income under U.S. generally accepted accounting principles (GAAP) fell by about 38% to $76 million. The period ended on July 29.
While housing prices have risen due to tight inventory conditions, sales have slowed. Existing home sales dropped by 2% in September, according to the National Association of Realtors. That looks like it will remain a major challenge to RH's business.
Expansion plans
But RH's management isn't standing pat. The company has several growth initiatives although it's too early to tell how these will pan out. These include expanding the number of galleries in North America and globally and increasing its online presence. Replicating the company's success in new locations and allowing customers to shop how they want seem logical extensions of RH's brand.
Its "product elevation" strategy involves phasing in new products. While management claimed early results were promising, it admitted that it was too early to draw any firm conclusions. Additionally, the company acknowledged short-term margin pressure as it phases out old products and launches new ones.
Management also plans to extend the product beyond furniture to include hotels, private jets, and luxury yachts. It's always challenging to build a brand and enter new markets where there's a sharp learning curve. This seems like an overreach.
Valuation
RH's stock price drop has resulted in a lower valuation. The shares trade at a price-to-earnings ratio (P/E) of 17, down from over 30 a couple of months ago. The S&P 500 has a P/E multiple of 24.
It would seem that RH's shares sell at a bargain, but the company's prospects look dim, given the housing market's sluggish sales. And its expansion plans don't seem likely to pay off in the near term, if at all. Based on that, I'd pass on the stock.
