Luxury furniture retailer RH (NYSE:RH) announced better-than-expected results in Q2 FY2023, with revenue down 19.3% year on year to $800.5 million. However, next quarter's revenue guidance of $750 million was less impressive, coming in 3.17% below analysts' estimates. Turning to EPS, RH made a non-GAAP profit of $3.93 per share, down from its profit of $8.08 per share in the same quarter last year.
RH (RH) Q2 FY2023 Highlights:
- Revenue: $800.5 million vs analyst estimates of $786 million (1.84% beat)
- EPS (non-GAAP): $3.93 vs analyst estimates of $2.60 (51% beat)
- Revenue Guidance for Q3 2023 is $750 million at the midpoint, below analyst estimates of $774.5 million
- The company reconfirmed its revenue guidance for the full year of $3.07 billion at the midpoint
- Free Cash Flow of $114.2 million, up from $23.4 million in the same quarter last year
- Gross Margin (GAAP): 47.5%, down from 52.8% in the same quarter last year
- Store Locations: 82 at quarter end, increasing by 1 over the last 12 months
Formerly known as Restoration Hardware, RH (NYSE:RH) is a specialty retailer that exclusively sells its own brand of of high-end furniture and home decor.
The core customer is typically affluent and discerning, with a taste for high-end home decor. RH’s aesthetic is simple and clean-lined, with a focus on neutral colors and natural materials such as wood, stone, and leather. Antique and vintage elements are also featured in many products. RH’s furniture tends to be larger in size, which means that it is better suited for spacious homes rather than apartments and urban living.
RH stores, referred to as galleries, are typically located in high-end shopping areas. They are known for their expansive size and elegant layouts. Some of the larger galleries feature multiple levels with patios and decks to feature outdoor furniture. Rather than selling all sofas in one area of the store and all rugs in another, RH galleries are designed to showcase the company's furniture and home decor products in complete room formats.
RH has a strong e-commerce offering, which was launched in 2007. The platform not only allows customers to browse and purchase its products but to also read customer reviews and use digital augmented reality products to help customers visual RH products in their own spaces.
Furniture retailers understand that ‘home is where the heart is’ but that no home is complete without that comfy sofa to kick back on or a dreamy bed to rest in. These stores focus on providing not only what is practically needed in a house but also aesthetics, style, and charm in the form of tables, lamps, and mirrors. Decades ago, it was thought that furniture would resist e-commerce because of the logistical challenges of shipping large furniture, but now you can buy a mattress online and get it in a box a few days later; so just like other retailers, furniture stores need to adapt to new realities and consumer behaviors.
Competitors offering higher-end furniture include public companies Arhaus (NASDAQ:ARHS), MillerKnoll (NASDAQ:MLKN), and Design Capital Ltd. (SEHK:1545). Private company West Elm is also a competitor.Sales Growth
RH is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex high growth rates because it's growing off a smaller base than its larger counterparts.
As you can see below, the company's annualized revenue growth rate of 5.05% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was mediocre despite closing stores.
This quarter, RH's revenue fell 19.3% year on year to $800.5 million but beat Wall Street's estimates by 1.84%. The company is guiding for a 13.7% year-on-year revenue decline next quarter to $750 million, a further deceleration from the 13.6% year-on-year decrease it recorded in the same quarter last year. Looking ahead, the Wall Street analysts covering the company expect revenue to remain relatively flat over the next 12 months.
Number of Stores
The number of stores a retailer operates is a major determinant of how much it can sell, and its growth is a critical driver of how quickly company-level sales can grow.
When a retailer like RH keeps its store footprint steady, it usually means that demand is stable and it's focused on improving its operational efficiency to increase profitability. Since last year, RH's store count increased by 1 locations, or 1.23%, to 82 total retail locations in the most recently reported quarter.
Taking a step back, the company has kept its physical footprint more or less flat over the last two years while other consumer retail businesses have opted for growth. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.
Gross Margin & Pricing Power
We prefer higher gross margins because they not only make it easier to generate more operating profits but also generally indicate product differentiation, negotiating leverage, and pricing power.
As you can see below, RH has averaged an exceptional 49.5% gross margin over the last two years. This means the company makes $0.50 for every $1 in revenue before accounting for its operating expenses. 
RH produced a 47.5% gross profit margin in Q2, marking a 5.3 percentage point decrease from 52.8% in the same quarter last year. Although the company could've performed better, we care more about its long-term trends rather than just one quarter. Additionally, a retailer's gross margin can often change due to factors outside its control, such as product discounting and dynamic input costs (think distribution and freight expenses to move goods). We'll keep a close eye on this.
Operating Margin
Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, RH generated an operating profit margin of 18.9%, down 5 percentage points year on year. This reduction was likely driven by weaker pricing power, as indicated by the company's larger drop in gross margin.
From an operational perspective, RH has been a well-managed company over the last two years. It's demonstrated elite profitability for a consumer retail business, boasting an average operating margin of 20.5%. EPS
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q2, RH reported EPS at $3.93, down from $8.08 in the same quarter a year ago. This print beat Wall Street's estimates by 51%, a welcome development that should delight shareholders.
Between FY2020 and FY2023, RH's adjusted diluted EPS grew 15.1%, translating into an unimpressive 5.03% average annual growth rate. This growth is materially higher than its revenue growth over the same period, indicating that RH has excelled in managing its expenses (leading to higher profitability), bought back a healthy chunk of its outstanding shares (leading to higher PER share earnings), or did some combination of both.
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
RH's free cash flow came in at $114.2 million in Q2, up 389% year on year. This result represents a 14.3% margin, 11.9 percentage points higher than its free cash flow margin in the same period last year.
Over the last eight quarters, RH has shown terrific cash profitability, enabling it to stay ahead of the competition by investing organically, acquiring other businesses, paying down debt, or returning capital to shareholders via share buybacks or dividends while maintaining a robust cash balance. The company's free cash flow margin has been among the best in consumer retail, averaging 8.95%. However, its margin has averaged year-on-year declines of 1.4 percentage points. Although we'd rather see free cash flow conversion increase, short-term fluctuations like this aren't a big deal.
Return on Invested Capital (ROIC)
RH has a strong competitive position and its management team has a stellar track record of successfully investing in profitable growth initiatives. Its five-year average return on invested capital (ROIC) is 47.9%, firmly placing it among the best consumer retail companies.
We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from RH's Q2 Results
With a market capitalization of $6.87 billion, RH is among smaller companies, but its $420.6 million cash balance and positive free cash flow over the last 12 months give us confidence that it has the resources needed to pursue a high-growth business strategy.
We were impressed by how significantly RH blew past analysts' EPS expectations this quarter. That really stood out as a positive in these results. However, the company's management team noted that it expects the luxury housing market and the broader economy to remain challenging throughout the rest of the year and into next year as mortgage rates stay near 20-year highs. Overall, this was a mixed quarter for RH and the commentary likely spooked investors. The company is down 8.11% on the results and currently trades at $339 per share.
Is Now The Time?
When considering an investment in RH, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. Although we've other favorites, we understand the arguments that RH isn't a bad business. However, its revenue growth has been mediocre over the last three years, and analysts expect growth rates to deteriorate from there. But while its decline in physical locations suggests that its demand is shrinking, the good news is its impressive operating margins indicate a highly efficient business model.
We don't really see a big opportunity in the stock at the moment, but in the end, beauty is in the eye of the beholder. If you like RH, it seems that it's trading at a reasonable price point.
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