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Approach Restoration Hardware Holdings, Inc Stock With Caution

Although Higher Earnings Guidance Helps RH Stock, A Controversial Buyback Should Give Investors Pause

By Will Healy, InvestorPlace Contributor

Restoration Hardware stock has a rosy future, but its debt obligations make it extremely unattractive

Source: Shutterstock

Restoration Hardware (NYSE:RH) surged in Tuesday’s session after the home-furnishing company beat earnings estimates in the first quarter. The company missed on revenue but RH stockholders focused on increased earnings guidance for the fiscal year.

If history is any indication, the rally could continue. However, considering some of the moves by management, investors should remain wary on RH stock.

Although increased guidance could lead to further gains, Restoration Hardware has likely realized most of the gains it will see in the near term.

RH Stock Beat on Earnings, Impressed on Guidance

RH reported earnings per share (EPS) of $1.33 for Q1. This exceeded Wall Street estimates by 31 cents per share. This also came in well ahead of Q1 numbers from last year, where RH stock saw five cents per share in net income. RH also reported revenues of $557.4 million dollars. This missed expectations by $5.76 million. Revenues also fell 0.8% from last year’s levels.

However, the earnings guidance drove the stock massively higher. For the second time this fiscal year, the company raised guidance to between $6.34 and $6.83 per share. Analysts had previously expected $5.85 per share. Revenue guidance more closely met expectations. The company expects between $2.53 billion and $2.57 billion in revenue this year. This closely matches the consensus estimate of $2.55 billion.

Volatility Drove RH Stock Throughout Its History

The company, which competes with the likes of Williams-Sonoma, Inc. (NYSE:WSM) and Bed Bath & Beyond, Inc. (NASDAQ:BBBY), has seen numerous ups and downs. Its previous stint as a publicly traded company ended soon after a substantial investment by Sears Holdings Corp (NASDAQ:SHLD) prompted rumors of a full takeover. Trading ended when the private equity firm now known as L Catterton took it private in 2008.

Since RH stock returned to public trading in 2012, it continued seeing significant amounts of volatility. The stock price rose above the $100 per share level in 2015 before falling back below its original initial public offering price.

Restoration Hardware stock traded below $25 per share as late as early 2017. Since then, however, it has seen a large move higher, culminating with the massive move higher following earnings.

Buybacks Prompted Much of the Recent Surge in RH stock

Unfortunately for new investors, most of that surge has come from one of the largest and most controversial share buybacks in history. In 2017, the company bought back an astounding 49.6% of RH stock in 98 trading days.

With little cash on the balance sheet, the company financed this primarily by nearly doubling its long-term debt. This debt rose from $576 million in its second quarter to $1.055 billion in the third quarter, a $479 million increase.

This took the stockholders’ equity from $623 million to -$47 million in the same period. Although stockholders’ equity is gradually moving toward positive territory, I find it difficult to trust stock gains that come from unbalancing the balance sheet.

Also, for that reason, the chance to buy into RH stock at a low valuation appears to have passed. However, RH stock bulls have an ally in the equity’s history. Today’s price surge takes the forward price-earnings (P/E) ratio to about 23.

The good news is if historical trends hold up, the stock could have further to move. Since 2012, RH has spent much of its history supporting P/E ratio between about 33 and 53. Even if the stock is attempting to regain its 33 P/E ratio, it could see another 30% move higher.

The massive guidance increase could also bode well for future estimates. Analysts had previously estimated that profit growth would slow into the mid-single-digits after fiscal 2020. However, the latest guidance has increased earnings to levels not expected until 2020. How today’s increased guidance affects earnings beyond 2020 remains to be seen.

The Bottom Line on RH Stock

Considering the moves by management over the past year, RH stock has likely seen most of the gains it will realize for the foreseeable future. To be sure, the increased guidance bodes well for the short-term future of RH stock, which saw a massive increase following the earnings announcement.

The move to take on massive debt levels to buy back stock, however, should give prospective investors pause.

Such a buyback indicates most of the near-term gains have likely already occurred. Also, with the willingness of management to take such an unnecessary gamble to juice the stock price, investors should never view RH stock as low-risk.

Risk-tolerant investors could buy Restoration Hardware’s stock today and enjoy some gains … for now. That said, I think investors can enjoy comparable gains without taking on the level of risk involved with RH stock.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

Article printed from InvestorPlace Media, https://investorplace.com/2018/06/approach-rh-stock-caution/.

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