A closer look at RH (Restoration Hardware)

Coming back to the stocks that recently popped up on my radar screen...

The second-most popular stock among the four I mentioned to my readers last week was luxury furnishings retailer RH (RH) – better known as Restoration Hardware. (The top one was Align Technology (ALGN), which I discussed in yesterday's e-mail.)

As a reminder, RH had tumbled by a staggering 40.1% last Thursday after reporting earnings per share that heavily missed expectations. CEO Gary Friedman even used a four-letter word (probably inadvertently) on the conference call when he heard how his company's stock was reacting.

This recent Wall Street Journal article has more details: The Day Trump's Tariffs Shook Corporate America. Excerpt:

Restoration Hardware Chief Executive Gary Friedman was on a call with analysts Wednesday afternoon talking about the furniture retailer's strategy and how the housing market could slow in this economic environment when news of the tariffs broke. He asked colleagues to get a "live read" of his business to check how the company's stock was doing.

"Oh really? Oh, s---, OK," Friedman said in the moment. "Everybody can see in our 10-K where we're sourcing from so it's not a secret."

More than 70% of the furniture company's products come from Asia, according to its annual report, including 35% from Vietnam and 23% from China, where steep new duties were put in place.

RH closed yesterday at $149.36 per share. It's down from more than $700 per share in 2021 and sits at a roughly five-year low, as you can see in this 10-year stock chart:

A move like that certainly gets my bargain-hunting heart racing. So today, let's take a closer look at the stock and see if there's a bottom-fishing opportunity here...

Looking at RH's financials, I'll start as usual with long-term revenue and net income:

This isn't very impressive...

As you can see, RH was barely breaking even in 2016 and 2017. It caught a tailwind during the COVID-19 pandemic as everyone stayed at home and bought nice home furnishings... but revenues have declined and profits have crashed since the world reopened.

Turning to the cash-flow statement, RH showed strong growth in free cash flow ("FCF") from 2018 to 2021. But since then, it has been all downhill – turning negative the past two years. And keep in mind, this is before the impact of tariffs.

The below chart of the company's cash from operations, capital expenditures ("capex"), and FCF tells the story...

I don't like the balance sheet, either. As you can see in the chart below, RH's net debt has tripled to $3.9 billion in the past three years:

The company's FCF over the past three years has been close to flat (an average of negative $17 million), so how has net debt risen by more than $2.5 billion?

To answer that, let's look at capital allocation on the cash-flow statement...

RH has never paid a dividend and hasn't made any material acquisitions, so we can see that the main reason its debt has soared is that it bought more than $2.2 billion of its own stock in 2022 and 2023:

At least the company didn't buy back stock at its absurd heights in 2021. But nevertheless, the share repurchases over the next two years were very poorly timed...

As you can see in the stock chart above, shares might have appeared cheap in those years – having been cut by more than half. In reality, they weren't cheap at all... as they were consistently more than double today's price. (This is a good lesson on the perils of anchoring on an artificially high price.)

We can see that the share repurchases in 2017 and in 2022 and 2023 reduced the share count, but in very different ways:

In 2017, RH spent about $1 billion and retired 14 million shares at an average price of about $72 per share. That's a smart use of cash.

But in 2022 and 2023, the company spent more than $2.2 billion and only reduced the share count by 11 million shares – at an average price above $200 per share, which also is well above current prices.

And now RH is saddled with a dangerously high debt burden (about $3.9 billion) that exceeds its $3.1 billion market cap (as of yesterday's close), giving it a roughly $7.0 billion enterprise value.

Is this cheap? Well, if you believe management's guidance, perhaps...

In its fourth-quarter earnings release last week, RH gave the following guidance for this year:

• Revenue growth in a range of 10% to 13%.
• Adjusted operating margin in a range of 14% to 15%.
• Adjusted earnings before income, taxes, depreciation, and amortization ("EBITDA") margin in a range of 20% to 21%.

Following this guidance, analysts are projecting earnings of $10.28 per share this year. That would mean that, as of yesterday's close, the stock is trading at 14.5 times its forward price to earnings.

But I would be skeptical of the guidance based on the profit and cash-flow trends of the past three years, plus the terrible capital allocation decision to lever up the balance sheet to buy back stock at inflated prices.

And now tariffs are a huge negative wild card that could literally bankrupt this business (though I don't think that's likely). Meanwhile, the odds of a recession that could really hurt the business have gone up as well.

Friedman has mostly been leading RH since 2001, when the company was on the verge of bankruptcy. After 17 years, RH finally had four great years from 2018 to 2021... but it has been all downhill since then. So perhaps his retailing genius isn't all that it seems.

I'll note that I have a number of smart friends who really like RH's stock. But based on what I'm seeing in the financials, not only isn't it even remotely interesting, but last week's 40% blowup should have been easily foreseeable.

Don't be tempted to bottom-fish this one...

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.