Are RH's Worst Days Behind It?
Refocusing on the core business with more relevant inventory has put RH in better position to match supply and demand of product ahead.
No-moat RH (RH) appears to be putting some difficult times behind. The company had struggled to right size its inventory base since the kickoff of RH Modern at the beginning of 2016, which was followed by some faster warehouse and outlet sales that weighed on profitability through the beginning of 2017. Lapping a weak 2016 and refocusing back on the core business with more relevant inventory has put RH in better position to match supply and demand of product ahead. We expect to move our $48 fair value estimate up modestly in response to improved gross margin stability ahead, at a likely higher rate (at least in the near term), but plan to maintain our long-term outlook, which incorporates high-single-digit sales growth and mid-teens earnings per share growth. With shares rising back into the above $60 range, we view RH as overvalued, and think some of the immediate gains are due to the lower float the company now has (RH repurchased half its shares earlier this year) and a high short interest in the name (up 30% recently).
The firm’s outlook for the second half incorporates adjusted gross margin performance well above the 34% average we have implied in our model, at between 36%-37%, which would add about $1 to our $48 fair value estimate, if we assume next year’s (2018) gross margin remains flat over the revised outlook. However, adjusted SG&A expenses are also forecast to come in a bit higher (50 basis points) than we had previously modeled over the second half, at around 28% which could offset some intrinsic value upside. Updated sales guidance ($2.42 billion-$2.46 billion) was largely in line with our prior fiscal year estimates, for $2.42 billion, however the adjusted net income outlook of $70 million-$77 million was well ahead of our $60 million forecast, given the higher gross margin performance anticipated ahead. Previously, our gross margin forecast normalized above 35%, but could nudge up slightly with this update. This could be offset by higher SG&A spend.
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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.