EUR 850.00 For Business Accounts Only

Morningstar | Profitability outpaces sales as RH continues to optimize its inventory and cash flow profiles.

RH has gained share in the fragmented $116 billion domestic furniture and home furnishing market in recent years, curating differentiated offerings from specialized artisans globally. The firm has broadened its brand awareness by expanding into underserved categories including modern and teen, where few peers have scale, attempting to capture incremental market share from boutique competitors. However, improvement in brand equity could rise or fall depending on the cadence of store and category expansions, but we think the retail business alone (around 65 core stores) still has insufficient scale to garner a cost advantage. Moreover, the categories RH operates in can become price-competitive under weaker economic conditions, supporting our no-moat thesis. RH uses its e-commerce business (44% of 2017 sales) to build the brand awareness and leverage costs, with the ability to market incremental SKUs. We expect that over time, RH is likely to focus on improving operating expenses through leverage in items such as shipping, occupancy, and advertising, although we think its primary focus will remain on optimizing its real estate profile over the next decade, with a near-term focus on sourcing proper inventory and capitalizing on an improved merchandising process, with product rationalization in the past. In 2017, RH announced efforts to untie significant amounts of capital by moving to a sale-leaseback model on its upcoming properties, utilizing reverse logistics to liquidate units in market and constraining the distribution center footprint (shuttering two locations and canceling the construction of another), helped by inventory that declined 30% in 2017, with another double-digit reduction expected in 2018. This puts RH on the path to achieve about 13% operating margins at the end of our forecast.RH remains tied to housing market conditions, and weakness in willingness to spend could lead to wide swings in profits (admittedly, housing indicators point to healthy spending over the near term). RH could have adjusted returns on invested capital of around 23% by 2022, compared with our 10% weighted average cost of capital, but note that this metric can be volatile.