RH's Transformation Initiatives On Track, Macro Woes Rife

On Jun 6, we initiated coverage on RH (NYSE:RH) – formerly known as Restoration Hardware -- a leading luxury retailer in the home furnishings marketplace.

The company’s efforts to redesign its supply chain network, rationalize product offerings, and the acquisition of Waterworks are encouraging. However, the uncertain macro environment raises concerns given the higher dependence on foreign manufacturing and imports.

Notably, RH’s shares have gained 49.3% year to date, compared to the Zacks categorized Retail-Home Furnishings industry’s 10.3% decline. Meanwhile, estimates for the current year and next have moved up by 17.6% and 22.5%, respectively, over the last 60 days. Also, RH recently reported impressive first-quarter fiscal 2017 results.



Q1 Highlights

RH reported first-quarter fiscal 2017 earnings per share of 5 cents, which were in line with the Zacks Consensus Estimate. However, the reported figure reflects a significant improvement over the loss of 5 cents in the prior-year quarter.

Revenues also increased 23% year over year to $562.1 million, surpassing the Zacks Consensus Estimate of $560.4 million by 0.3%. The upside is attributable to the acquisition of Waterworks, higher outlet sales and the company’s inventory optimization efforts. The acquisition of Waterworks accounted for about six percentage points of revenue growth. RH’s comparable brand revenues increased 9% year over year, compared with the 4% increase in the prior-year quarter.

Adjusted operating margin expanded 130 basis points (bps), while adjusted gross margin improved 80 bps.

At the end of the fiscal first quarter, RH operated 85 retail outlets, higher than 69 in the prior-year quarter.

Key Positives

In fiscal 2016, the company transformed its business from a promotional to a membership model (RH Members Program), which is expected to enhance its brand, streamline operations and improve customer experience. Also, initiatives like RH Modern, RH Teen, RH Hospitality, the redesign of RH Interiors Source Book, the rollout of Design Ateliers across the company’s retail Galleries are expected to contribute to growth in 2017 and beyond.

The addition of Waterworks is expected to prove accretive to earnings in the years to come. RH owns in excess of 90% of the total equity interest in Waterworks. Notably, Waterworks is the only complete bath and kitchen business offering fittings, fixtures, furniture, furnishings, accessories, lighting, hardware and surfaces under one brand in the market. Waterworks’ products are sold through 15 showrooms in the U.S. and the U.K. as well as through its boutique retail partners, hospitality division and online. Net revenues attributable to Waterworks represented $28.6 million of the company’s net revenues in the first quarter of fiscal 2017.

Concerns

RH’s business highly depends on global trade. In fiscal 2016, the company sourced approximately 88% of its merchandise from outside the U.S., including 78% from Asia, the majority of which originated from China. Thus, any economic or regulatory changes in the foreign countries will affect RH’s business.

RH’s valuation looks a bit stretched when compared to the industry average. Looking at the company’s price-to-earnings (P/E) ratio, the company currently has a trailing 12-month P/E ratio of 32.72. RH is overvalued compared to its peers as the industry’s average over the past five years stands at 18.59. Moreover, RH’s trailing 12-month return on equity (ROE) undercuts its growth potential. The company’s ROE of 5.92% has shown a gradual decline over the last few years. Further, it compares unfavorably with ROE of 23.03% for the Zacks categorized Retail-Home Furnishings industry, reflecting its inefficiency in using shareholders’ funds.

Zacks Rank & Stocks to Consider

RH carries a Zacks Rank #3 (Hold).

Better-ranked stocks in the Retail-Wholesale sector include Darden Restaurants, Inc. (NYSE:DRI) , Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) and Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) .

Red Robin Gourmet sports a Zacks Rank #1 (Strong Buy). Full-year 2017 earnings for the company are expected to increase 2.8%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Dave & Buster's, a Zacks Rank #2 (Buy) stock, is likely to witness 15.6% earnings growth in fiscal 2017.

Darden, also a Zacks Rank #2 stock, is expected to see 12.9% growth in fiscal 2017 earnings.

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