Restoration Hardware (NYSE:RH)’s 2023 results indicated signs of stabilization and offered an optimistic outlook for a potential business rebound. The new releases of RH Outdoor and Modern collections have received positive initial reactions, with further product transformations anticipated through to 2025. Overall, RH’s unique strategy of positioning itself as a leader in luxury furniture design is a double-edged sword. Taste is subjective and difficult to quantify, so investors need to closely monitor RH’s product offerings and compare them with competitors to make well-informed investment decisions. After my last article, I decided to downgrade the stock to a Hold rating. I believe investors should wait to confirm the outcomes of the recent product transformation investment before making further decisions.
Business update
For the full year of 2023, RH reported a revenue of $3.03 billion, reflecting a decline of 15.6% compared to the previous year. The gross profit margin fell to 45.9%, down from 50.47% the previous year. SG&A costs increased to 33.12% from 30.1% last year. As a result, the operating margin dropped to 13% from 20%, indicating a clear decline in business performance for 2023. However, there were signs of stabilization in the fourth quarter. The year-over-year revenue decline for Q4 2023 was 4.43%, the smallest decrease since Q3 2022. Notably, if the $40 million revenue impact due to shipping delays related to January weather and conflicts in the Red Sea is considered, Q4 2023 revenue would have been $778 million, $8 million higher than the same quarter last year. This adjustment suggests that RH gained market share from peers such as Williams-Sonoma, which saw a 5% decline in sales, and another peer that experienced a 3% decline in sales.
Product transformation is still the key priority even under market downturn
The post-pandemic macro environment has not been favorable for RH. High home prices and rising interest and mortgage rates have deterred some people from investing in a second home or renovating their existing ones. Additionally, the recent increase in travel has reduced the high demand for homes that was seen during the pandemic. Despite these challenges, RH has not scaled back its investment in its brand. Instead, it has accelerated these efforts. As CEO Gary Friedman noted during the recent earnings call,
we faced the most challenging housing market in three decades while investing in the most compelling product transformation and platform expansion in our history.
A wave of multiple product lines and galleries is coming in 2024. This includes the launch of the RH outdoor sourcebook, updated RH modern sourcebook, updated RH interiors sourcebook, and updated RH contemporary sourcebook. All these new designs will be coupled with new collections, refreshed galleries, and improved in-stocks. In 2024, RH plans to open 5 gallaries in North America, all with design offices, restaurants, and wine bars. Two international gallaries openings include 1 in Brussels, and another in Madrids. RH Paris is delayed to 2025 because of the 2024 Olympics. RH Sydney development just received approval with plans to open in the fall 2026. There is also a launch of a 3500 square foot Waterworks Showroom, focus on bath and kitching products , in California aiming to open in Q4 2024. What’s more, the development of collections will continue with the introductions of RH Couture, RH Bespoke, RH Color, RH Antiques & Artifacts, RH Atelier and other new collections scheduled to launch over the next decade.
The emphasis on delivering unique designs
RH’s product transformation, encompassing its galleries, design studios, and various hospitality initiatives, has established a comprehensive ecosystem for luxury spaces. The company has excelled with recent launches such as RH Outdoor and RH Modern, which feature unique designs and exceptional quality. The presentation of these products has been impressive, further solidifying RH’s reputation for consistently delivering high-end offerings. By focusing on affluent clientele, RH effectively gathers high-quality data, enabling them to stay well-informed and ahead of emerging design trends. I think this strategic approach ensures that RH remains at the forefront of the luxury market, with their products being highly distinguishable and setting a benchmark for design excellence.
RH is also very smart on leveraging its assets to elevate it design capabilities. As RH grows bigger and attracts more high-net-worth individuals, it can collect data, test new ideas, and predict consumer preferences. There will also be more designers willing to sign deals with them, who often have more insights on the field. We can see the current RH style looks very neutral in color but rich in details and form. This could have a timeless appeal and accommodate a wide range of tastes.
Risks of being ‘an arbiter of taste’
On the other hand, the heavy investments in design and styling may introduce significant uncertainty for shareholders. As RH ambitiously expands its business by position itself as ‘an arbiter of taste’, it could face challenges such as rapidly changing trends, potential confusion regarding brand identity, and increased production complexity. The sustainability of a luxury brand’s success solely based on design is questionable. Additionally, furniture designs can be quickly replicated and modified, inadvertently providing competitors with free design development. It remains unclear whether RH’s additional costs on design will yield a good return for investors. Therefore, investors should closely monitor RH’s new product releases to assess whether their designs and styling remain at the forefront of innovation.
Bottom Line
Overall, in my opinion, RH stands out as the most innovative and productive business in the luxury furniture sector. Its CEO, Gary Friedman, is a true visionary, holding a 25% stake in the company and demonstrating a strong commitment to its success. The 2024 outlook predicts a demand growth of 12-14% and revenue growth of 8-10%, indicating RH’s ambition to return to growth. This target surpasses those of competitors such as Williams-Sonoma and Arhaus. If RH meets these expectations, it could signal that its product transformation is effective and that the company is poised for market share gains moving forward.
However, significant capital expenditure (around $270 million) will be required for expansions in Europe. The current $8 billion enterprise value seems high in the short term, given that free cash flow remains in negative territory. In the long term, though, if we believe in the 20% operational margin target set by Gary Friedman and assume a 10% revenue growth, RH has the potential to achieve substantial free cash flow of around $800 million in 10 years as the macroeconomic conditions improve. Given Gary’s willingness to buy back shares aggressively, the stock price is unlikely to stay at low valuations for long once RH’s business prospects improve.
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