RH Earnings: Luxury Housing Spending Under Pressure, but Intact Fundamentals Support Profit Upside

No-moat RH’s RH top line continues to struggle due to a sour housing environment that has been hindered by high mortgage rates and limited turnover, resulting in a furniture and home furnishing industry average sales decline of 7.2% in its last quarter. Luxury housing-related spending wasn’t spared, as evidenced by RH’s second-quarter sales decline of 19% (to $800 million), which modestly edged our negative 22% forecast. However, an adjusted operating margin of 20.2% significantly exceeded our 14.5% outlook, helped by $40 million of marketing spending that was reallocated to the third quarter. As such, RH is poised for a midteen sales decline and an operating margin of 8%-10% in the current quarter, a massive compression (roughly 1,200 basis points) that likely accounts for shares tumbling 8% in postmarket trading. Fortunately, the third quarter appears to be the trough in sales and profit pressure, as the implied fourth-quarter guidance includes flat sales (down 8%, excluding the 53rd week) and a 15.5% operating margin at the midpoint. With the 2023 outlook largely unchanged, we don’t plan any material change to our $312 fair value estimate and view shares as modestly overvalued.

Despite a pullback in housing spending—which we expect will prove transitory—RH continues to seek out differentiated opportunities, most recently bidding for the development of One Ocean Drive Miami. This will be its initial endeavor into a membership offering with a beach club, a pool terrace, and a bath house and spa, a clear continuation of its its luxury brand expansion. Such efforts, along with the European expansion, line extensions, and an existing facility facelift should support long-term average sales growth of 8%, ahead of the mid-single-digit rise we expect for the repair and remodel market (a proxy for RH’s growth). With relatively light capital intensity, such investments should return RH to profit expansion in 2024 and keep ROICs above 20%, over our 10% WACC estimate.