RH Turns Lemons Into Lemonade
The carpe diem crackpots in Corte Madera take puffery to a new level via the term vector.
Thursday afternoon, Restoration Hardware (RH - $321.87) reported Q2 2024 results that were in-line with the company’s guidance ranges (revenue, EBIT%). In addition, the company lowered its full year guidance ranges.
The lowered fiscal year guidance was no big surprise given the macroeconomic backdrop and recent reports from its peers.
What moved the stock higher on Friday was the CEO’s top-line puffery.
While admitting that the top-line inflection “developed a couple of quarters later than expected,” the CEO then went on to say the following…
“We believe the important measure is not the timing, but rather the size of the vector we are creating in comparison to our industry. Vectors are measured in magnitude and direction, and can be effective in forecasting strategic separation and future market share gains. It is now clear that our vector is increasing by both measures as we are outperforming the industry by 15 to 25 points.”
Vectors! Yep, the carpe diem crackpots (I’m only half kidding) have came up with another unique word or phrase to describe the company’s financial performance.
But, while the company is pointing out today’s ‘vector’ they conveniently ignored the “reverse vector” of significant market share losses over the past 2-3 years.
I certainly agree that RH is taking market share today. This fact was clearly implied in the company’s Q2 2024 revenue guidance provided 3 months ago.
But, the question is why? Context is needed.
There is some key information that was not included in the above CEO comment that helps explain why RH is “taking market share” today. Let’s go through a few of the company’s idiosyncratic top-line drivers.
The company has previously disclosed that it is doubling its catalog circulation this year versus last year. Increased catalog circulation is a key top-line driver for the home furnishings space.
The company is on pace to add +11% store square footage this year (ex-outlets) following a +10% increase in FY 2023. Many of the new stores are in new markets for the company (e.g., Dusseldorf, Munich, Brussels, Madrid and Montecito, CA) or, larger more attractive store relocations here in the U.S. (e.g., Indianapolis, Cleveland, Palo Alto, Newport Beach, Raleigh).
The newly ‘transformed’ product should be gaining traction and generating excitement/buzz.
The company’s bloated levels of inventory likely suggest that it is sitting on outsized levels of legacy inventory that needs to be sold-off via the outlet channel. Note that the company stopped disclosing its outlet channel sales at the end of last year. Hmm. In FY 2023, the outlet channel represented approximately 8% of the company’s total revenue.
Again, context matters. Let’s say you start a weight-loss campaign by gaining 20 lbs. the first month and then lose 5 lbs. the second month. Certainly, losing 5 lbs. may be (optimistically) a vector in the right direction. But, you’re still 15 lbs. in negative territory. That’s RH today.
I get it. What CEO Friedman is doing is human nature. The company has had a dismal 10-quarter stretch and he’s trying to positively ‘spin’ the company’s newfound sales growth.
Here’s a look at just how dismal RH’s performance has been since Q1 2022…
It’s clear that CEO Friedman was itching to grab a bullhorn and proclaim victory, even if a bit premature.
Then, at least for me, things got interesting in the middle of the Q&A session of the Q2 2024 conference call on Thursday afternoon. During one of CEO Friedman’s prolonged diatribes, he called me a “sideline critic” in response to a report I wrote for clients re: RH. Also, he took umbrage for me not visiting the company and implied how could I “learn anything” without conversing with the company.
Here’s his quote…
I have a couple of thoughts re: his “sideline critic” comment.
I actively follow 40 consumer companies (primarily retailers). I have followed most of these 40 companies for 15-20 years.
Since re-joining the sell-side last year, I send my reports to each company (via email). I leave it to the company whether they wish to engage with me. Most do not (probably two-thirds).
Why do most companies choose to not engage with me? Generally, I ask more thoughtful questions. But, more importantly, I ask FOLLOW-UP questions. In other words, I don’t stop until I get an answer to the question or, an acknowledgement that management will not answer the question… sometimes a reasonable outcome given fair disclosure regulations.
Most sell-side analysts are afraid to press management teams to answer the difficult questions. Why? Their business model is highly dependent on their access to management (via selling seats at meetings with management teams).
Therefore, when I come along and actually press management teams to answer (or, not answer) difficult questions, they’re generally taken aback. It’s an approach they’re just not used to.
I’m okay with digging deeper into the publicly available data and conference call transcripts than my peers. I’ve established a long track record of successfully forecasting EPS divergence in the next 12-18 months relative to consensus expectations.
Conversely, forecasting short-term movements in stock prices is not my bread-and-butter and in my view is a fool’s errand.
Finally, since CEO Friedman appeared to call me out on the conference call, below is the note that triggered him…
I would turn the tables on Mr. Friedman. What in my report above does he disagree with?
I’m sure the disagrees with the “dud” comment. But, given the disastrous financial performance over the past 10 fiscal quarters, I’ll stand by that comment today. Otherwise, most of the report (ex-estimates) is largely factual.
I’ve emailed Mr. Friedman and his IR representative to set-up a time to ask him some questions. I’m happy to throw some thoughtful questions his way. To this juncture, no response.
The reality is that RH provides less financial disclosure than its peer WSM. For example, RH provides investors few details re: profitability changes versus the prior year. That would be my starting point.
But, I’m also curious about the level of outlet channel sales in Q2 2024 versus LY (given the bloated level of inventory) and why the company decided to no longer disclose outlet channel sales each quarter.
I have many others. If I don’t hear back from Mr. Friedman, I’ll put together a post late next week with a list of questions that I think would help investors get a better holistic understanding of the company’s recent performance and whether the company’s vector talking point has legs.
What happened in Q2 2024 was predictable. The stock price move on Friday was not.
The stock price move was a function of what may be the premature lighting of a victory cigar by Mr. Friedman. Only time will tell. But, it will be fascinating to watch given Mr. Friedman’s irrational exuberance on Thursday.