The no-moat company has failed to generate sales growth commensurate with footprint expansion.
By Jaime M. Katz, CFA | 12-08-16 | 09:25 PM | Email Article

Despite nearly 30% average square footage growth over the last year, no-moat  Restoration Hardware  has failed to generate sales growth commensurate with footprint expansion. With third quarter sales rising just 3% in total, and facing top-line declines at a double-digit pace during the fourth quarter, it seems RH’s sales resurrection remains at bay. While pointing to some factors that have impacted the business in the current year, including the ongoing SKU rationalization program and the sourcebook delay from spring to fall, we also think issues including luxury headwinds could persist for longer than expected, as President-elect Trump takes office and uncertainty remains front of mind for many consumers. Further, rising interest rates tend to be less favorable for metrics like housing turnover ahead, and while we don’t think slight upticks in mortgage rates will waylay high income consumers over the near term, they could hinder them over time. We plan to adjust our $48 fair value estimate by about $1 to adjust for near-term downside, which will likely include top-line growth of 1% with EPS contracting more than 50% (from 3% growth and 39% declines prior).

Jaime Katz, CFA, is a senior equity analyst for Morningstar.

Longer term, we believe RH can reignite sales growth and our model forecasts average top-line growth through the end of our forecast of 9% as square footage growth averages nearly 10% over the same time. Here, as higher sales stem from new galleries (to the tune of 2 times legacy stores or more, according to RH), expenses should leverage. Our forecast includes gross margins that bounce back starting in 2017, and expense leverage of only 70 basis points over the next decade, as some new endeavors, like wholly owning the delivery process, are likely to weigh on profit growth. This could lead earnings to remain below last year’s level ($2.72) until 2018. We also expect free cash flow to turn positive again in 2017, but could turn negative further out, as the build-out and spend cycle could prove lumpy.

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Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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