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RH Surges 46% Year to Date: Can the Bull Run Continue?

Zacks Equity Research

RH RH has been riding high on the back of its focus on improving profit margins, and creating a new and differentiating shopping experience with the incorporation of hospitality (restaurants and cafes) in new galleries. Shares of RH, a leading luxury retailer in the home furnishing space, have gained 45.8% year to date compared with the industry’s 29.3% rally. Also, it has outperformed the S&P 500’s 22.3% rise in the said period.

Its price performance is backed by an impressive earnings surprise history, having surpassed the Zacks Consensus Estimate in five of the trailing six quarters. Earnings estimates for fiscal 2020 and 2021 have moved up 1.3% and 2.6%, respectively, over the past 60 days. This positive trend signifies bullish analysts’ sentiments and justifies the company’s Zacks Rank #1 (Strong Buy), indicating robust fundamentals and the expectation of outperformance in the near term. You can see the complete list of today’s Zacks #1 Rank stocks here.

What’s Working in Favor of the Stock?

Initiatives to Drive Profitability: RH has been architecting a new operating platform that includes transitioning from a promotional to a membership model, distribution center network redesign, reorganization of the reverse logistics and outlet business, along with reconceptualization of home delivery and customer experience. These initiatives have helped the company to lower costs and inventory levels, while boosting earnings and inventory turns. Going forward, RH expects this multi-year effort to result in a dramatically improved customer experience, continuous margin enhancement and significant cost savings over the next several years.

Meanwhile, RH has successfully transformed the business from a promotional to a membership model (RH Members Program), which is expected to enhance its brand, streamline operations and improve customer experience. Its members, which totaled approximately 418,000 at the end of fiscal 2018, drove approximately 95% of fiscal 2018 sales in core RH business. Notably, core RH business reflects the product categories in which membership discount can be applied. Hence, sales derived through Outlet, Contract, Hospitality or Waterworks are excluded.

Stellar Performance: RH has been exhibiting strong profitability, buoyed by focus on improving profit margins, and creating a new and differentiating shopping experience with the addition of hospitality (restaurants and cafes) in new galleries. Focus on elevating brand and architecting an integrated operating platform have aided RH in becoming one of the few retailers with expanding margins, rising operating earnings, while driving significantly higher returns on invested capital (industry-leading ROIC was 27.8% as of fiscal 2018).

In the first six months of fiscal 2019, the company’s net sales recorded a 8.9% increase. Its adjusted earnings grew an impressive 53.8% during the period on the back of significant growth in operating margin and lower adjusted effective tax rate. Adjusted gross margin was 40.7%, expanding 100 basis points (bps) from the year-ago level. Adjusted operating margins also grew 300 bps to 13.4% in the period.

Upbeat View: Despite increase in tariffs and some negative macro trends, RH remains optimistic about business momentum, buoyed by factors that include the recent mailing of the Fall Interiors and soon to be in-home Modern Source Books, increasing contribution from RH Beach House, the launch of RH Ski House, along with new Galleries opening this fall.

In view of the recent trends, the company raised its full-year guidance for net revenues, adjusted operating income, operating margin and earnings during fiscal second-quarter earnings call. The company’s focus on elevating the brand and architecting an integrated operating platform continues to reflect in its profit model leapfrogging past the home furnishings industry that includes companies like Ethan Allen Interiors Inc. ETH, At Home Group Inc. HOME and Williams-Sonoma, Inc. WSM. Management believes that it is gradually becoming one of the few retailers that are persistently boosting revenues, expanding margins, increasing operating earnings and driving significantly higher returns on invested capital.

The company has solid prospects, as is evident from the Zacks Consensus Estimate for fiscal 2019 and 2020 earnings of $10.81 and $12.39 per share, which indicates 26.6% and 14.7% growth, respectively, on a year-over-year basis.

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