RH Stock Will Recover As Investors Reward the Company’s Brutal Honesty

  • RH (RH) shares have been in freefall in 2022.
  • The collapse accelerated when the company warned of a major sales slowdown in March.
  • However, it has become clear this is an industry-wide problem, and RH isn’t uniquely at risk.
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High-end furniture company RH (NYSE:RH) has had a volatile year. RH stock is down 54% year-to-date and more than 60% from its 2021 highs.

After its steep fall, shares are going for just 10 times forward earnings. What caused investors to suddenly throw in the towel on this luxury retailer? Things really got going in March, when the company warned investors that demand for its products had suddenly declined.

Traders dumped the stock following the news. However, subsequent events have shown that RH’s decline was part of a broader macroeconomic turn, rather than anything specific to its own business. As such, RH stock should recover as investors reprice shares accordingly. At its present valuation, RH is a bargain compared to most of its retail peers.

RH RH $245.04

RH’s CEO Gave a Stark Warning Back In March

RH CEO Gary Friedman gave a bold statement about the company’s outlook back in March on its latest quarterly earnings call. Friedman is known as a straight-shooter. And he lived up to that reputation in March, warning analysts that the company’s demand had suddenly plunged.

Following the beginning of the Ukraine conflict and sudden gas price spike, Friedman said that RH’s business volumes had rapidly diminished:

“Our demand got hit by 10 to 12 points. We’re not actually guiding demand. I just wanted to give you color that there has been a change … I think it’s going to be that way for everybody … Other people might be banging a brighter, happier drum than me. Do they have better numbers than we do? I don’t think so.”

Elsewhere in the call, Friedman warned that the Federal Reserve was out of touch with the economy and that a recession was coming. RH stock plunged following this stark message. RH was one of the first major companies to warn investors that the Ukraine conflict had served as a tipping point to stifle consumer demand. However, as Friedman warned, the optimists banging a “happier drum” have now — in May — admitted to a similar downward shift in consumer activity.

Walmart and Target Confirm the Slowdown

The retail sector was faring alright for most of 2022. However, that abruptly changed last week as both Walmart (NYSE:WMT) and Target (NYSE:TGT) announced disastrous earnings. Both companies had their single largest one-day declines since 1987, with Target in particular diving 25% in a single trading session. For stable conservative retail operators such as those two, the speed of the crash was nearly unprecedented.

Walmart was noteworthy as the company had inventory build up more than 30% during the quarter. This means that Walmart ordered way too much of certain high-ticket goods, which simply didn’t move off the shelves as the company had expected. After not being able to keep products in stock in 2021, now Walmart and Target are suddenly facing gluts of major discretionary categories of products.

Other retailers, such as some apparel names, have posted similarly downbeat numbers this quarter. Like a light switch, consumer demand for non-essential products turned off early this year.

Consumers Are Still Spending… But Not On High-Ticket Furniture

It’s easy to look at rising topline retail sales and wonder why retailers are faring so poorly. Consumers haven’t stopped spending. But they’ve moved from high-margin impulse and discretionary purchases back toward essentials.

Let’s unpack that a bit. Consumer spending is still strong on certain items. Retail sales in categories such as food, gasoline and household products are up sharply year-over-year.

You can probably see the issue there. An economy isn’t humming simply because people are paying way more for toilet paper, milk and gasoline than they did last year. These are essential goods with inelastic demand curves. Double the price of food or shampoo and people are still going to buy almost exactly the same amount.

However, something like furniture in general and, in particular, RH’s brand of luxurious furnishings is not essential. People are looking to trim parts of the budget to afford higher costs for basic everyday goods. In such a time, a company like RH is first to see its sales fall.

RH Stock Verdict

My premise is that RH stock has been unfairly punished because it was the first major consumer discretionary company to sound the alarm on the sudden economic slowdown. Traders felt that perhaps RH had simply bungled its operations. After all, it’s quite rare that a company’s sales trajectory unexpectedly drops by a double-digit amount in a single month.

However, the recent results from Target, Walmart and various other retailers confirm that the consumer discretionary sector has suddenly lost steam. This isn’t a problem specific to RH but rather a broader economic concern. Thus, RH stock shouldn’t be uniquely in the penalty box.

Should RH stock be down 20% or 30% this year with the decline in consumer spending and the potential slowdown in the housing market? Sure, a 25% haircut would be justifiable given the headwinds. However, the current 50%-plus year-to-date decline for RH stock seems grossly excessive. That could make shares a solid bounce-back buy in coming weeks and months.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2022/05/rh-stock-will-recover-as-investors-reward-the-companys-brutal-honesty/.

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