Shares of the RH (NYSE:RH) fell off a cliff in late March after the luxury furniture retailer reported fourth-quarter numbers that didn’t live up to expectations. After a substantial trimming of next year’s guide, Restoration Hardware investors got spooked by the bearish outlook and drove RH stock down 20%.
While management blamed the rethink on “negative trends in the high end housing market” to start 2019, it seems to me that this sell-off looks like a buying opportunity in RH stock.
The former Restoration Hardware’s long-term growth fundamentals remain healthy, as the luxury furniture retail market is a stable growth industry globally, and RH is doing everything right to expand share in that stable market. Given those healthy long-term fundamentals, operational turbulence in early 2019 looks more like noise than anything else. Further, this noise may be muted later this year, as housing market fundamentals are already showing signs of improving.
Thus, this noise isn’t that big of a deal, it’s temporary, and it will likely drown out within the next few months. Yet, it’s also plunged RH stock into undervalued territory.
This disconnect is an opportunity. Although the near term may be choppy, Restoration Hardware stock has a solid opportunity to stage a sizable recovery rally over the next several months.
Not a Great Quarter, but Weakness is Temporary
RH’s fourth-quarter report wasn’t great because it reflected the reality that U.S. economy is slowing, and that Restoration Hardware isn’t exempt from this slowdown.
Over the past two years, Restoration Hardware has been firing on all cylinders as the company has transitioned from a promotional-based business model, to a membership-based format. Simultaneously, the company has taken an experience-driven approach to furniture retailing, has turned their stores into interior design showrooms, and has created a truly unique and differentiated luxury furniture retail shopping destination which consumers have resonated with. Sales have risen rapidly. Margins have expanded dramatically. Profits have soared.
To be sure, this red-hot growth narrative is finally slowing. Specifically, the U.S. housing market fumbled in late 2018 amid rising mortgage rates and economic slowdown concerns. As it did, the luxury housing market was hit, too, and Restoration Hardware’s growth slowed. Consequently, management has substantially reduced their fiscal 2019 guide, and is now calling for just 4% revenue growth next year with relatively small margin expansion (versus the prior guide of 10% revenue growth and strong margin expansion, which has been the norm for this company for several quarters).
Still, if the U.S. housing market continues to slow, RH’s growth trajectory will continue to flatten out. But, the U.S. housing market is already showing signs of turning around. Housing starts and home permits are off to soft start this year, but it’s not as bad as many feared. Mortgage rates are still falling. Wages are still rising. Financial markets have found their footing.
Overall, there’s reason to believe that the U.S. housing market struggles of late won’t last. If they don’t, recent weakness in Restoration Hardware stock won’t last, either.
Fundamentals Support Higher Prices
At current levels, RH stock seems fundamentally undervalued, and ready for a big rally on any good news.
Earnings next year are expected around $8.75 per share. RH stock trades hands around $105, or at just 12 times forward earnings. That’s pretty cheap. The market average forward multiple is 16x. Among home improvement stocks, it’s 18x. Among consumer discretionary stocks, it’s 20x.
In other words, RH stock is really cheap. That value only makes sense if profits aren’t going to grow over the next several years. But, they should grow, and by a meaningful amount. Even in what management sees as a depressed year, revenue is still expected to rise 4% in 2019. Profits are expected to increase about 15%. Meanwhile, even though management’s long-term 10% revenue growth and mid-teens margin targets seem aggressive, luxury furniture market average 4% revenue growth plus slight margin expansion should drive healthy profit growth for the foreseeable future.
Healthy profit growth is a steal at 12x forward earnings. As such, RH stock looks tasty on this dip. If sentiment normalizes, you could easily see this stock get a market average 16x forward multiple. If so, RH stock could be trading closer to $140 within the next few months.
Bottom Line on RH Stock
After several consecutive quarters of red-hot growth, Restoration Hardware is finally hitting a rough patch amid a slowing U.S. housing market. Still, this weakness isn’t a huge deal (the long-term fundamentals remain healthy), and it’s likely temporary (U.S. housing market data is improving).
As such, with temporary fears pushing RH stock into deeply undervalued territory, now seems like the right time to get bullish.
As of this writing, Luke Lango was long RH stock.
