RH (RH 135.95, -15.33, -10.13%), the luxury
furniture and home furnishings retailer, delivered an impressive Q2 earnings
blow-out last night as EPS surged by over 280% year/year to $2.49 versus the
$1.75 consensus. Back in 2016, the company began transitioning away from a
promotional model to a membership-based model in which it would focus on
product quality, rationalizing its product assortment, and redesigning its
supply chain network. The primary goal was to drive earnings growth rather than
revenue growth as management says it has seen the failures of other furniture
retailers as they chased high growth through free shipping, endless promotions,
and a shrinking store base.
With RH achieving record adjusted gross margin of 12.3% compared to 6.4% a year ago, driving the aforementioned surge in earnings growth, it's safe to say it is successfully executing on its plan. Going forward, the company says it will continue to focus on implementing this business model, while decreasing inventory and capital spending, resulting in strong cash flow through earnings growth. On the topic of cash flow, for the quarter, RH generated over $25 mln in free cash flow, allowing it to lower its ratio of net debt to Adjusted EBITDA to 2.4x versus 5x at the end of 2Q17.
That's the good news.
While the bottom line growth is impressive, investors seem to honing in on the Q2 revenue shortfall, as well as its downside revenue guidance for Q3, Q4, and FY19. First, for Q2, revenue grew by 3.7% to $642 mln, missing the $661 mln consensus by a fairly wide margin. Comparable brands sales increased 5%, up from the 1% growth posted last quarter. However, last quarter saw total revenue dip by 1%. This is only the second time RH suffered a year/year decline. Further, the 3.7% mark this quarter was also one of the weakest as a publicly traded company.
In regard to its outlook, RH guided for Q3 revenue of $624-$636 mln compared to the $647 mln consensus; Q4 revenue of $665-$685 mln versus the $692 mln consensus; and FY19 revenue of $2.489-$2.521 bln versus the $2.56 bln consensus. Additionally, EPS guidance was only inline for both Q3 and Q4, while RH provided upside EPS guidance of $7.35-$7.75 versus the $6.76 estimate. Excluding Q2's EPS blow out, RH's EPS guidance for FY19 would land at $6.81 at the mid-point, virtually in-line with consensus.
In its earnings press release, management did comment on the top-line issues. Specifically, it stated that while it would like to improve its accuracy in terms of forecasting revenue, it is difficult given the inventory optimization efforts. The company doesn't seem overly concerned about it, stating that it is difficult to be too disappointed when adjusted gross margin is up 800 basis points and adjusted diluted EPS are up more than 3x compared to last year.
RH will also be looking to drive stronger growth in 2019 as it returns to a product expansion strategy, which has been on hold. This strategy will include adding new brands such as RH Beach House and RH Color, and, it will expand its assortments on other key categories as well. Additionally, RH is opening four new galleries in Portland, Nashville, Yountville, and New York, and it intends to develop new galleries that are tailored for smaller markets, targeted to be 10,000-18,000 square feet. The plan is to test a few of these galleries over the next several years, and if those are successful, it will look to further expand.
To conclude, RH's strategy to drive enhanced margins and profits is clearly playing out as planned. For the moment, investors are disappointed in the top-line performance and are concerned that growth is tapering off, perhaps at a faster rate than anticipated. In short, if revenue growth takes a more pronounced dive, as investors seem to be fearing, then RH's plan to drive earnings growth would ultimately also take a hit.
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