Restoration Time

3/1/15

In looking to take advantage of a stronger US dollar and ever improving consumer, I’m taking a look at the home furnishings business, and more specifically, Restoration Hardware (RH). Restoration has about 90 stores, about 20% of which are outlet stores. Recently, RH expanded their direct-to-consumer catalogue size by almost 100% as the company expanded into kitchen, small spaces and baby and child furnishings, all areas which I see have the most growth in the company. Kitchens are becoming the most popular remodeling jobs, smaller apartments and condos with more amenities are the way of the future, and as the unemployment rate comes down and consumer confidence builds up, more couples are having babies. But the future of Restoration Hardware is more than just babies and kitchens.

Along with an expanded product line, the company has already updated most of its current retail locations, and is now moving into larger Full Line Design Galleries like the one in Atlanta, with another 30 locations being planned. Atlanta is the house of a 6 story, 70,000 sq. ft. estate, including an 8,000 sq. ft. rooftop with skyline views. In these new, larger locations, RH is better able to control costs and increase margins because instead of occupying multiple spaces in nearby cities with limited space for their products, they will now be able to showcase every product in every product line with a second-to-none shopping experience, allowing the consumer to see everything set up as if it was in their own house. On RH’s earnings call last December, CEO, Gary Friedman, talked about how the RH product line is always evolving because the world is always evolving. They have differentiated their product line which was is inspired by midcentury modern to English antiques, to Italian, Spanish and Asian influence, allowing the company to appeal to the mass market. So, in these new Taj Mahal type locations, customers have a one-stop shop to see all designs and styles to fit their homes.

In this day and age, it takes more than just a great product to grow sales and differentiate your company. Management has focused on two of the most important aspects for future growth: the in-store experience (as evidenced by their Atlanta and future locations) and technology. As I mentioned earlier, they increased the size of their catalogues to 3,300 pages from 1,600 pages to include every product the company sells. Now, here’s what’s really great about their catalogue business…you don’t have to get it in the mail and store a 3,300 page book in your home. Every single one of their catalogues are digital and found directly on their website and mobile app. If you only want to look at European style furniture, you can go directly to those pages with one click of a button. What would a midcentury modern couch look like in your 600 sq. foot condo…just click a button. Their digital catalogue gives the user the experience of being in their stores but from the comfort of their own home. In a world that is becoming more reliant on technology, this experience is key to success. Not only that, but like Chipotle has success telling it’s customers about the quality of the product and where it comes from, Restoration Hardware has biographies and extensive information about its artists who sell artwork in their locations, to give the user more background into who the artist is and how their work is inspired.

The company doesn’t report FY14 and Q4 earnings until the end of March, but on February 5^th, management pre-announced strong results, with revenues expected to grow 24% YoY to $1.868. Comparable brand revenue has increased 50% in the last two years, showing that the company can beat difficult comps. The company also increased the lower end of their EPS guidance by $0.01/share. CEO Gary Friedman commented, “RH continues to outperform the home furnishings industry by a wide margin. FY14 marks RH’s 5^th consecutive year of net revenue growth in excess of 20% -further demonstrating the disruptive nature of the RH brand and the power of our multi-channel business model.” Management remains focused on becoming the leading luxury home brand and are targeting $4-$5B in US sales, mid-teens operating margins and strong free cash flow. The company currently trades about around 35x FY15 earnings, but I think the high valuation is warranted for such strong growth and being an industry leader.

Technically, the stock looks great. RH has found strong support at $85, rallying to $88.10 on Friday, and not dipping below the 200-day moving average since last June. That $85 level is key for the stock because the 61.8% Fibonacci retracement is at $84.86. I think the stock can go to $107, giving you a 22% gain. The future of RH looks bright, and I think this is one of those stocks that you can buy and hold for the long haul.

My current positions: Long Ford (F), Gilead Sciences (GILD), Starbucks (SBUX), Macy’s (M), Google (GOOGL), Facebook (FB), Delta Airlines (DAL), Whole Foods (WFM), Wells Fargo (WFC), General Motors (GM), ConocoPhillips (COP), Kinder Morgan (KMI), Time Warner (TWX), Palo Alto Networks (PANW), Twitter (TWTR), NXP Semiconductors (NXPI), Lockheed Martin (LMT), Darden Restaurants (DRI), Celgene (CELG), Mobileye (MBLY), Jack In The Box (JACK), Under Armour (UA), Masco (MAS), United Rentals (URI), and Regeneron (REGN).

Jeff Lewison