RH: Ongoing Product Rationalization Affects Results
The long-term growth cadence of demand could be slowing, despite changes to the business.
No-moat RH (RH) offered an updated outlook for its first quarter, which includes faster-than-anticipated revenue growth and rising gross margin pressure as the team continues to rationalize stock-keeping units. The company now expects sales of $558 million-$562 million, implying a 23% growth rate at the midpoint, versus the prior outlook of $530 million-$545 million and our internal estimate of around $532 million. However, 6 points of the growth was from the 2016 addition of Waterworks, and another 6 points came from higher outlet and warehouse sales, leaving around 11% that could be attributed to the core business. This is slower than the midteens to 20% range that the company was delivering before the hiccups that began in the first quarter of 2016, implying that the long-term growth cadence of demand could be slowing, despite changes to the business.
Furthermore, the company narrowed its outlook for earnings per share to $0.03-$0.05 from $0.02-$0.06, indicating that despite faster-than-anticipated sales, RH has been subject to increasing gross margin pressure. It noted that higher outlet sales and related markdowns and inventory reserves were the culprit, indicating pricing power is difficult to glean; this supports our no-moat rating. While gross margins could still be ahead of last year's depressed 30% level in the first quarter, we still expect them to be widely behind the three-year first-quarter average of 34% that was generated over 2013-15. We don’t anticipate any material change to our $46 fair value estimate and view the shares as overvalued, trading at more than 25 times forecast 2017 EPS.
Our long-term outlook still includes high-single-digit top-line growth, contingent on continued square footage expansion, along with 250 basis points of selling, general, and administrative expense leverage and 300 basis points of gross margin expansion, leading to operating margins that reach above 10% from our 6% forecast for 2017.
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Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.