RH: Staying On The Fence Until Uncertainties Clear (NYSE:RH)

Thesis

Given the new questions that have been raised by the update on February 4, 2023 and the shifting consensus outlook, I still find it difficult to commit to a position on RH (NYSE:RH) stock. However, I believe a more substantial re-rating is possible once sales stabilize (as they appear to be doing) and market expectations on details (such as tax rates) are all in sync. Finally, I believe RH will maintain its share buyback program in order to boost EPS growth. Over the longer term, I continue to be confident that RH will be able to achieve its long-term goals of 8-12% revenue growth, a mid-20s EBIT margin, and mid- to high-teens EPS growth thanks to its ability to extend its brand, domestic strategy, and European growth potential.

Key takeaways from release on February 4, 2023

The announcement contains a few crucial nuggets of information. For my part, I think the 4Q forecast cut and sales commentary were the most important takeaway. In addition, the number of shares repurchased during the fourth quarter and the previously reported GAAP EPS have been revised to reflect the impact of the extinguishment of debt accounting. Lastly, in response to an SEC letter, RH will also begin using a pro forma non-GAAP tax rate that is greater than zero. Based on my read, it seems likely that the reduced guidance and increased tax impact will cause the consensus/investors to adjust EPS downward following this update.

Financial metric updates

Adjusted operating margin is expected to be closer to the upper end of the previous range, while revenue growth is anticipated to be at the lower end of the prior range. This would imply a 4Q EBIT of around $120 million, which is lower than consensus initial estimates of $128 million. I would anticipate a much larger impact on EPS, however, given that consensus was modeling a 0% tax rate. Assuming a tax rate of 21%, EPS would come to about $2.80, much lower than the $3.51 estimated by consensus. One thing to note is I am assuming a rate of 21% based on past practice as management has not yet decided on a final tax rate.

The higher tax rate will be partially offset by the share repurchase announced in the release, so I expect the impact to the consensus FY23 numbers to be minimal. While it’s clear that a share repurchase would be beneficial, the question is how much. According to my calculations, it would increase consensus FY23 EPS by 2 to 3 points, helping to mitigate the negative effects of a potentially higher tax rate.

Guidance

Despite these positive developments, my impression is that RH’s order book barely accelerated in Q4 in light of the updated revenue forecast. On the other hand, it appears that the sales and EBIT margin for FY22 are likely to meet the previously stated targets, indicating that the company’s performance may be stabilizing and potentially reaching a low point.

More on share repurchase

It appears to me that RH is increasing the frequency of its buybacks, as indicated by the company’s proxy statement. As things stand, I anticipate RH will maintain its buyback program. Overall, I think these buybacks are good news because they show management’s optimism that underlying conditions may be stabilizing, and they lend credence to my belief that EPS growth can be enhanced via buybacks.

Risks to monitor

Cyclicality in the housing market

Despite signs of improvement in the housing market, in a recession consumers typically hold off on major purchases. The home furnishings retail industry is also known for its price sensitivity. Thus, RH’s performance could be hurt by weaker-than-anticipated housing demand, especially in the luxury segment.

Competition

If competition in the luxury home furnishings market increases, RH may need to respond by offering discounts or increased promotions to remain competitive.

Conclusion

In conclusion, RH’s updated FY22 outlook shows signs of sales stabilizing, which could lead to a re-rating of the stock. The recent announcement also includes important information on the revised 4Q guidance, the number of shares repurchased, and the impact of extinguishment of debt accounting. Guidance wise, adjusted operating margin is expected to be at the upper end of the previous range, while revenue growth is anticipated to be at the lower end. RH is also likely to maintain its share buyback program, which could help boost EPS growth. However, the risks of cyclicality in the housing market and increased competition in the luxury home furnishings market need to be monitored.

Overall, RH’s long-term goals of 8-12% revenue growth, mid-20s EBIT margin, and mid- to high-teens EPS growth remain achievable.