Restoration Hardware – Don’t Let Revs Miss Scare You

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Restoration Hardware (RH) is the classic example of private equity swooping in and reaping massive rewards for its risk.

Restoration Hardware Holdings NYSE:RHThe company was on the verge of bankruptcy in 2007 when private equity firms Catterton Partners and Tower Three Partners gobbled up the chain for a mere $177 million.

The two PE firms then took Restoration Hardware public, with RH stock debuting at $24 per share, making the company worth almost $900 million. Today, Restoration Hardware is worth $3.2 billion, with RH stock more than tripling since the IPO.

I guess private equity did something right.

Restoration Hardware seems to have found favor again with consumers. It targets the class of consumer that goes for a professionally designed product, it sells nice stuff, and it does so in upscale malls and neighborhoods. So I’ve always rooted for Restoration Hardware because … well, I like what they do.

I’m not so universally bullish on the company’s recent earnings, however.

There was a lot to like up front. Some highlights:

  • Net revenues increased 14%, which is a very nice improvement, and even came on top of a 30% increase the year before. Comparable-brand revenues increased by about the same amount, at 13%, also on top of a 30% increase last year.
  • Meanwhile, margins were solid at 11.3%.
  • Adjusted operating income zipped up 43% to almost $49 million.
  • Adjusted net income rocketed 40% to $27.7 million. (Translated to earnings per share, adjusted diluted EPS shot up by 37%.)

So why did RH stock open Thursday trading down 2%?

For one, everyone seems upset at a $20 million revenue miss. Restoration Hardware also guided full-year revenues to $1.85 billion to $1.87 billion, down from a high of $1.89 billion.

This seems to have sent everyone into a tizzy, but I don’t see the big deal.

Restoration Hardware’s diluted EPS range is still $2.29 to $2.33, which would put RH stock (trading at $80 as of this writing) at nearly 35 times estimates. That’s a lofty number, but the midrange of $2.31 per share still is a 35% improvement over the previous year. And the next year’s EPS estimates are pegged at $2.91, which would mean another 26% increase.

Meanhwhile, Restoration Hardware has $182 million in cash and $112 million in long-term obligations, so that’s $70 imllion in net cash, or around $2 per share. Certainly not the bankrupt company from seven years ago, is it?

Cash flow is a different matter. Restoration Hardware had $31 million in operating cash flow last year in this quarter, offset almost entire by $30 million in capital expenditures. However, this year, operating cash flow was negative by almost $30 million, with another $39 million in capex draining the bucket.

Bottom Line

Restoration Hardware is re-making its brand, aiming at a “full line” approach, and expanding on its 68 store base. Management appears focused and has a specific notion of what its brand is and is pursuing it.

Still, I want to see cash flow improve, and I don’t want to see sales falter any more. As a growth stock, these are potential stumbling blocks that could crater a stock.

And what about valuation? Well, if you wanted to compare, I guess you could consider Macy’s (M) and Williams-Sonoma (WSM) to be competitors, but they aren’t quite the same thing. Macy’s goes after a more discount type of consumer. WSM is more the upscale brand, but its catalog of offerings feels different. Nonetheless, Williams-Sonoma and Macy’s trade at much better price-to-earnings ratios. (Though for what it’s worth, WSM also is trading at a price/earnings-to-growth ratio of almost 2, and that’s too expensive.)

I would wait and see how the next quarter or two shape up before paying upwards of 30x for RH stock.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/restoration-hardware-rh-stock-earnings/.

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