After the close last
night, luxury furniture and home decor company, RH (RH 139.62, +15.97, +12.92%) posted an impressive
beat-and-raise 3Q18 report, which had shares surging higher by nearly 15% in
early morning trading. Once again, RH delivered an earnings blow-out, just as
it did in Q2 and Q1, as it continues to reap the benefits of its strategy to
move away from a promotional model to a membership-based one. More on that
Back in 2016, the company made the decision to transition from a promotional model to a membership-based one, in which it would focus on product quality, rationalizing product assortment, and redesigning its supply chain network. Although the strategy has resulted in a set-back in terms of revenue growth, it clearly has had the desired effect of pushing both margins and earnings growth higher.
Taking a look at the
headline numbers, RH generated EPS of $1.73, crushing its own guidance of
$1.15-$1.33 as well as the $1.27 consensus, while soaring by 66% from a year
ago. Revenue growth also accelerated to 7% from 3% last quarter, coming in at
$636.6 mln versus the $632.3 mln expectation. Generally speaking, the company
attributed these strong results to full-price selling, improved outlet margins,
and continued cost benefits from its new operating model.
A couple other key operating metrics for RH are comparable brand revenues and adjusted operating margin, and both of these also demonstrated the underlying strength in the business. Specifically, comparable brand revenue was up 4%, on top of a difficult 6% increase in the year ago quarter. Furthermore, this is despite the fact that slower special order receipts from China, due to tariff-related shipping issues, negatively impacted the metric by about 1%.
The company believes
that the pick-up in revenue growth and solid comparable brand sales performance
are a function of continued market share expansion. Lending credence to this is
that RH's growth has gained steam, while the luxury housing market has slowed
throughout the year. During the earnings call last night, management stated
that it believes it can continue to gain share, even if conditions in the
housing market remain soft.
While demand has improved for RH, the company also continues to leverage the business and execute on its goal of driving higher earnings growth through improved margins. Specifically, for the quarter, RH's adjusted operating margin expanded to 10.3% from 8.3% in the year ago quarter.
Additionally, the company has been making some positive changes to its cost structure. For instance, its efforts to reduce inventories and redesign its distribution center enabled it to close a 500,000 square foot distribution center in Baltimore in Q3. This led to approximately $4 mln in annual net savings. Going forward, RH will also be moving from a leasing model to a development model for its new openings, including doing sale-leasebacks, which will allow it to recoup all of its up-front capital.
Due to the better-than-expected early success of its new business model, RH was able to move its long-term financial targets ahead by another full year. It now expects to reach low-to-mid teens operating margins and RoIC of approximately 35% by FY19. From a demand standpoint, the company continues to believe there is a $4-$5 bln opportunity in North American revenues, with an international opportunity that could lead to the company becoming a $7-$10 bln global brand.
In order to capitalize on that expansive addressable market, the company now plans to pivot back to a more growth-oriented strategy starting in FY19. This will include accelerating its real estate plans, opening 5-7 new galleries per year, up from 3-5 per year. Also, RH has developed a new RH prototype "Design Gallery" that will enable it to more quickly place product assortment into the market. These will be smaller in size compared to its traditional galleries, ranging in size from 29,000-33,000 square feet. The reduced square footage is expected to be more capital efficient with less time and cost risk, but, with similar yield productivity.
To conclude, RH's new business model is clearly paying dividends for the company, in the form of sharply higher margins and earnings. Now, as it completes this transformation, it looks to build its brand out, re-focusing on generating stronger top-line growth.