Up 40%, RH (RH) Stock May Go Even Higher

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RH (NYSE:RH) is reinventing itself, and Wall Street loves it. The luxury home furnishings retailer reported blowout second-quarter results on Wednesday. The company also delivered a jaw dropping earnings guide for 2017 which blew the consensus estimate out of the water.

Up 40%, RH (RH) Stock May Go Even Higher

The result? RH stock is up 40%. Yes. You read that right. A whopping 40% move in a day. RH stock, though, is still off its mid-July highs. Does that mean there is more room for RH stock to head even higher?

Maybe. Here’s why.

RH Has Its Act Together

Here’s the quick rundown on what is going on at RH.

2016 was a year of big investment and a big change for the company. RH transformed its business from a promotional to a membership model. They redesigned their supply chain network and decided to aggressively clear inventory in an attempt to rationalize the product offering. They launched brand new business initiatives like RH Modern and RH Teen. Even the Source Book got a face-lift.

2017 has been a year of reaping the rewards of 2016’s investments, while also being a year of continued operational changes. Comparable brand revenues are strongly positive. Total revenues are also up healthily. Return rates, exchange rates, and cancellation rates are all down. Merchandise margins in the core business are up. Adjusted earnings grew by nearly 50% in the second quarter.

Overall, the growth picture looks pretty good this year. But the company is still in the midst of executing some pretty big operational changes.

RH had a bunch of outlet sales in the quarter (46%-plus year-over-year) as the company is aggressively trying to clear inventory. Those heavy markdowns dragged on gross margins. RH still has some excess inventory to clear in the third quarter, but management expects outlet margins to normalize by the fourth quarter.

By next year, the outlet business should be in a healthy spot. This year, the company is selling a bunch of units at low margins. But next year, RH will sell fewer units at considerably higher margins. The net result should be flattish outlet sales growth, but robust gross profit growth.

Meanwhile, RH is consolidating its distribution network. This consolidation should help merch margins improve next year while also eliminating a pretty big chunk of operating expenses.  RH is also redesigning their product return process, and management expects this redesign to reduce transportation and handling costs by about $15 to $20 million annually.

So 2018 will be a year almost purely of rewards from heavy 2016 and 2017 investment. Sales growth will remain healthy, but a lot of costs will come out of the system. That means earnings growth should be pretty big.

How big?

I think its likely RH can do anywhere from $3.50 to $4 in earnings per share next year. The mid-point of that range implies just under 50% earnings growth year-over-year.

Bottom Line on RH Stock

Taking $3.75 as a reasonable estimate for EPS next year, RH stock is trading at 18.4-times next year’s earnings. The S&P 500, meanwhile, is trading around 16.9 times next year’s earnings.

So RH stock and S&P 500 are trading at similar forward valuations. But RH has much more growth potential into perpetuity. Granted, earnings growth is super-charged this year and next year by a bunch of cost-saving initiatives, but its also worth noting that this is a company which thinks it can get to $4 to $5 billion in North American sales.

Total revenues this year are expected to be under $2.5 billion.

So this is a business that could potentially more than double its sales, implying double-digit revenue growth will sustain itself over the next several years. That sort of revenue growth coupled with significant expense leverage should lead to earnings growth in excess of 15-20% annually even after 2018.

The S&P 500 will be lucky to grow earnings around a 10% clip annually after 2018. From this standpoint, its reasonable to claim that RH is a growth stock still trading at a discount. That is a good setup for this rally continue.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, https://investorplace.com/2017/09/up-40-rh-rh-stock-may-go-even-higher/.

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