Solid Performance From RH, but Shares Pricey

No-moat RH (RH) reported third-quarter results that were roughly in line with its November update, calling for sales of $592 million and EPS of $1.03, above the company’s initial take in September. Sales of $592 million and EPS of $1.04 were supported by store sales growth of 12% and a direct-to-consumer sales rise of 3%, with same-store sales ticking up 6% on top of a 6% decline in the year-ago period. We recently reevaluated our long-term thesis on RH after its investor day. While our outlook for home furnishing and housing demand is unchanged, the firm’s change to its business model has likely placed it on track to reach higher operating margins than we previously modeled (at just below 10% versus 8.5% prior).

At the time, we raised our fair value estimate to $81 from $53 per share after incorporating lower capital expenditures (accounting for $14 of the increase), better near-term performance (adding $5 to our prior fair value estimate), and operating efficiencies ahead (fewer distribution centers to manage, improved SKU management), leading to operating margin expansion (providing the remainder of the hike). With the fourth quarter outlook unchanged ($655 million-$680 million in revenue and $1.31-$1.51 in EPS) we don’t plan any material change to our $81 fair value estimate and still view shares as pricey, trading at 18 times our tax-adjusted 2018 EPS estimate.

Gross margin performance in the quarter was solid, expanding 460 basis points to 36.9% after contracting 440 basis points in third-quarter 2016, lapping the SKU rationalization that was undertaken in 2016. The SG&A ratio was a bit better than we anticipated, at 28.8%, ticking down a modest 20 basis points, but still inflated from 2015 levels as the company reinvests in improving the supply chain. While we expect healthy operating margin gains in 2018, with RH returning to more normalized levels, we expect gains to moderate thereafter, with operating margins reaching about 10% over our long-term outlook.

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