To Accelerate Growth, RH Is Going Against the Grain

Steve Symington, The Motley Fool

Updated Fri, Apr 5, 2019, 6:09 PM

Sure, RH's fourth quarter was technically mixed relative to expectations. On the one hand, revenue climbed slightly from the same year-ago period, to $670.9 million, but fell short of consensus estimates for $687 million. Adjusted (non-GAAP) earnings, on the other hand, soared 76% to $76 million, and rose 78% on a per-share basis to $3, beating estimates by $0.15 per share.

Contemporary room decorated with RH products.

IMAGE SOURCE: RH.

But the market was more concerned with RH's disappointing forward outlook. In particular, RH now anticipates full-year 2019 revenue of $2.58 billion to $2.635 billion, good for growth of 3% to 5% from 2018, but marking a significant reduction from the 8% to 12% guidance it provided in December. Similarly on the bottom line, RH sees 2019 adjusted earnings per share of $8.41 to $9.09, well below its previous outlook for earnings in the range of $9.30 to $10.70 per share.

Equally to blame for the guidance reduction, according to RH management, are "market volatility and negative trends in high end housing," as well as the company's decision to "edit" unprofitable and nonstrategic businesses. In particular on the latter, RH is getting rid of its remaining holiday business and fringe promotions, as well as transitioning to a direct-sourcing model for its rug business.

Opening new physical stores, spurning "digital first"

But that also raises the question: Apart from simply waiting out the headwinds facing the high-end housing industry, what else is RH doing to turn this ship around?

According to RH Chairman and CEO Gary Friedman in his latest letter to shareholders, the company is taking several counterintuitive steps in the name of driving longer-term growth.

First, even as many retailers are closing their brick-and-mortar locations, RH plans to accelerate retail Gallery openings to five to seven new stores per year (up from its previous goal of three to five). Most, if not all, of these locations will include the company's integrated RH Hospitality, offering a "high-quality food and beverage experience" RH believes should help drive incremental traffic to its stores.

Second, while many competitors embrace promotions in the name of taking market share and driving top-line growth, RH is instead moving to a membership model in an effort to further differentiate itself.

Third, while other retailers opt not to print paper catalogs, RH insists on continuing to mail Source Books to highlight curated and inspiring designs from each of its store concepts. Going forward, this will include dedicated Source Books for the launches of several new brand extensions, including RH Beach House this spring and RH Ski House in the fall.

Finally, Friedman notes RH "refus[es] to follow the herd in self-promotion on social media, instead allowing our brand to be defined by the taste, design, and quality of the products and experiences we are creating."

In particular, he lamented that so many retailers of late have adopted so-called digital-first strategies, which negatively impact operating margins with the dedication of capital toward "building complex 'Omni-channel capabilities,' while leaving their retail stores to rot."

Friedman concluded:

We believe when you step back and consider: one, we are building a brand with no peer; two, we are creating a customer experience that cannot be replicated online; and three, we have total control of our brand from concept to customer, you realize what we are building is extremely rare in today's retail landscape, and we would argue, will also prove to be equally valuable.

The bottom line

Of course, shareholders will still need to come to terms with RH's reduced 2019 outlook in the meantime. But they can also take some solace knowing the company simultaneously reaffirmed its longer-term targets for 8% to 12% annual revenue growth, 15% to 20% annual adjusted earnings growth, and return on invested capital of at least 50%.

However, until RH demonstrates more tangible signs that its rebellious approach toward achieving those goals is yielding fruit, I suspect its share price will remain under pressure.

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