Value Investors Club / Restoration Hardware (RH)

Description

ELEVATOR PITCH

Restoration Hardware Holdings, Inc (RH) is a leading retailer of high-end home furnishings in North America primarily

sold direct to consumer through 67 core showroom stores (“galleries”) and their website. +95% of core RH sales are to

their 415K members who pay a $100 annual fee in return for regular 25% lower pricing and complimentary interior design

services which are used by ~65% of retail customers. RH curates its products from leading designers that desire to partner

with RH because of their scale and high-end brand association resulting in a higher quality for price and broader assortment

than competitors are able to offer. RH is a long because;

• RH is transitioning to a luxury home furnishings brand but trades at a ~25-50% discount to luxury peers.

• We believe there is a runway to increase revenue by ~200% over the next 8-10 years through store upgrades &

geo. expansion.

• There’s ~25-33% margin upside from product premiumization, a transition to capital lite stores & SG&A leverage.

• RH is the only scaled high-end home furnishings retailer leading to a better value prop & significant moat.

• CEO Gary Friedman is a visionary that has a track-record of creating significant shareholder value.

o RH stock has outperformed AMZN since its 2012 IPO.

o He’s aligned with us; +90% of net worth in RH, $290m comp package w/ top strike price at +60%.

o He’s an aggressive capital allocator; RH has bought back 50% of RH since 2017 at 80% below current.

We believe RH may compound EPS at ~17% and the P/E multiple to expand modestly from 23x to 25x, driven by a

partial re-rating as RH increasingly resembles luxury comps and has success internationally, potentially resulting in a 2 year

PT of ~$700 / 50% upside.

BUSINESS SUMMARY

RH sells high-end home furnishings primarily through 67 RH galleries and on their website (“RH Core”), which account

for 90% of revenue and greater >90% of EBIT. Their galleries are all currently located in North America and mainly

consist of 43 “legacy” 10K square foot galleries and 24 “design” 30K square foot galleries. They are in the process of

converting the majority of their legacy galleries to design galleries, which produce significantly better unit economics (2x

sales / >2x contribution profit, <2 year payback) and allow RH to offer the customer a higher end experience (better

interior design services, on site restaurant). RH’s typical customer is an affluent individual with an annual household

income of +$250K. The remaining 10% of RH sales are mainly from their outlet business where they sell returned items

and a separate high end bath / kitchen retailer Waterworks which they opportunistically acquired for $116MM in 2016 but

have yet to integrate.

KEY THESIS POINTS

RH is evolving into a luxury company that we believe should trade at a near luxury multiple.

• RH is well on its way to becoming

the

luxury brand of home furnishings.

o RH has and continues to transform from a commoditized furniture retailer to a high-end luxury brand.

▪ In 2016, the company introduced a paid membership model (>95% of sales today are from

members), and moved the business further up-market firmly into the realm of luxury by

increasing the product quality / price points and creating version 2.0 of their gallery store concept

which are 3x the size of version 1.0 and highly curated upscale experiences that are unrivaled in

luxury retail.

o RH’s current financial metrics are already similar to the best luxury brands in the world.

▪ ROIC: 26% with a path to +30% ROICs, Gross Margins: ~50%, Pricing Power: ~5% annual

price increases and no time-based promotions, Advertising Spend: Less than 4% of sales.

• Luxury brands trade for 50-100% higher multiples than RH currently does.

o As previously noted, RH has similar financial metrics to luxury companies and is quickly becoming the

luxury brand in home furnishings

o Additionally, we believe RH will grow earnings ~15-20% for many years vs. consensus earnings growth

expectations of ~10% for the luxury companies.

o We believe RH’s valuation multiple to partially close the gap vs. the luxury peers as investors increasingly

gain an appreciation that RH is becoming a luxury brand and not just a furniture company through

continued impressive financial results and as RH seems to prove that their brand will resonate

internationally.

In our view, RH has the potential to 4x EPS over the next 7-10 years from gallery footprint

optimization and geographic expansion.

• We believe RH has a credible pathway to 4x earnings over the next 7-10 years.

o Gallery Conversions (1-1.5x earnings uplift): RH has converted 24 of its "legacy galleries" to its larger

footprint "design galleries" at attractive economics. The Company plans to convert an additional 35-45

galleries for a total of 60-70 in the US.

o New US Galleries (0.5-1x earnings uplift): RH penetration of the US luxury remains low at ~6%. In

addition to gallery conversion, we conservatively estimate that RH can grow earnings through additional

galleries in locations they are not present in today that have the population size and wealth that look

similar to their existing markets.

o International Galleries (0.75-1.25x): RH is only present in North America today, but is planning to open

its first store in the UK in 2022 and France in 2022, and are in discussions for leases on 7 locations across

Europe. If the concept works in Europe, we believe that there is capacity for ~20 galleries. Similar to the

US there is no scaled high-end furniture competitor in Europe and many of RH's furniture designers are

already popular in Europe

• When RH converts a legacy gallery to its new design gallery format sales double, it appears that

contribution profit increases by ~1.4x, incremental ROICs are close to ~50% and the payback period is

less than two years.

o We believe the gallery conversions lead to higher sales because 1) the design galleries are very attractive

retail concepts that attract foot traffic; 2) they often contain popular rooftop restaurants and; 3) they are

able to display 2-3x the furniture of the legacy galleries – when a piece furniture is displayed in gallery (vs.

just in the catalogue and online) on average it sells at a 50-150% higher rate.

o RH is also increasingly benefitting from capital lite deals where landlords now contribute 65% of the capex

costs vs. 35-50% previously (tailwind to ROICs) because as RH has moved up-market and added a

hospitality offering they have become a more desirable tenant that can drive affluent foot traffic.

KEY RISKS

• Key Man Risk

• Brick & Mortar Dependent

• Housing Market / Stay at Home

CATALYSTS

• Earnings beats

• Successful international expansion in 2022

Disclosure:

We and our affiliates are long Restoration Hardware Holdings, Inc (NYSE: RH) and may buy additional shares or sell

some or all of our securities, at any time. We have no obligation to inform anybody of any changes in our views of RH.

This is not a recommendation to buy or sell securities. Our research should not be taken for certainty. Please conduct

your own research and reach your own conclusion.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

• Earnings beats

• Successful international expansion in 2022

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			2021	2022
Price:	472.00	EPS	0	0
Shares Out. (in M):	20	P/E	0	0
Market Cap (in $M):	9,629	P/FCF	0	0
Net Debt (in $M):	1,500	EBIT	0	0
TEV (in $M):	11,129	TEV/EBIT	0	0