COVID-19 is rushing across the nation and stocks are plummeting. Fundasy knows that there’s a shortage of toilet paper, which leads to crappy situations. However, there’s not a shortage of beaten down awesome stocks though. So, we went shopping.
What is RH?
Essentially RH is a fancy furniture store. Other furniture vendors, in an effort to deal with online shopping, have downsized, decreased catalog mailing, and increased promotional discounts. RH decided to do the opposite of all of those. They constructed massive galleries, created a membership model, put restaurants and bars in their galleries, and bought back 60% of outstanding shares at an average price of $61. Similarly to Emma Watson in Harry Potter 2-4, the transformation did wonders:
Why Does Fundasy Like RH?
STABLE GROWING REVENUE: The company’s strategy towards luxury furniture is working. You don’t go online and just casually purchase a $5,000 couch. You have to sit on that couch. You have to feel what it would be like to gorge on popcorn, while watching Die Hard (of course?). The revenue doesn’t lie. Their strategy is working. They created an experience that cannot be replicated online, and in 2019 they had around 7% revenue growth with opening no new locations. This success is not shared among furniture vendors at the moment and as other retail vendors go out of business, the strongest remain and get stronger. This is similar to the .01% of germs that hand sanitizer doesn’t kill.
MARGIN GROWTH: RH used to sell lower cost, more seasonal, items. Because of this, since the transformation in 2017, the company’s gross margins have risen from 31% to 41%. Before Corona (BC) RH stated that they expected these to continue to rise a few more percentage points in 2020. In 2 months BC, the company was growing revenue and margins. The company saw long-term operating margin around 20%, when it’s currently at 14% (lots more profit). Eventually, the company will return to status-quo and, assuming these trends continue, the price will follow.
CREATING SHAREHOLDER VALUE: Gary Friedman took over RH in 2013 and since then has killed the S&P 500, even with this most recent pull back.
Between the pullback in 2017 and late 2018, Gary Friedman bought back 60% of outstanding shares at an average price of $61. Even with a slightly growing business model, Friedman killed the S&P with its EPS growth. This is good management and capital allocation at its core. However, the pieces have been put in place for future expansion.
EXPANSION: I like that RH can create shareholder value and grow revenue without expanding it’s footprint. However, the company is planning on future growth in the years ahead. In late 2019, the company launched its RH Beach House and RH Ski House collections. In addition, new galleries are now being built after RH Build, their new internal construction company, was formed and put to work. Expansion to Europe is taking place over the next few years, and the brand will start to go global. With having its own construction company, expansion will require less capital and the company can keep a stronger balance sheet in tough markets. For a company with excellent capital allocation, it’s a recipe for success.
VALUATION: It’s hard/impossible to tell what future results will look like with corona-virus. I can tell you what they company’s end of 2019 valuation look like though.
- Price to Sales: 0.9
- Price to Earnings: 12.3
- PEG: 0.7
- Price to EBITDA: 8.4
Take all those numbers as you will, but they’re all BC values. AC will be lower for the short term, but long term values will eventually return to normal. If you think a hard six months will put the money out of business, avoid at all costs. If you think that a 50% price cut is a good opportunity, it might be time to start a small position. If it drops some more, buy some more. It can’t drop another 50% without going out of business.
The company will not do well short term. Sales will decrease and the EPS will waver. Their inventory comes from China, so that will be a major struggle as well. All looks absolutely terrible. That’s why the share price dropped 50 percent.
Individual companies can get hit harder in downturns. They also offer the greatest reward in good times. Fundasy recommends this name because it’s a great company, and it’s already dropped 50 percent. It will grow moving forward in the new decade and EPS growth will follow. Buy when others are fearful. Berkshire Hathaway has also been buying this name up in the last year, wonder what they’re going to do when the price keeps decreasing…food for thought.
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***Here at Fundasy, we are long on RH. Make your own damn decisions and do your own research though.