Sometimes stocks become newsworthy for a huge merger, an unbelievable scandal (think American Apparel) or stunning earnings results. However, since the advent of social media and internet marketing, stocks can also gain nationwide attention as a result of a public relations or marketing blunder that attracts all sorts of online attention that eventually translates into the offline world.
Restoration Hardware (RH) is an example of this phenomenon, with the company and the stock recently gaining media coverage for the wrong reasons. The incident was the 17-pound, thousand page catalog that the company mailed out to thousands of businesses and customers across the United States. Environmental groups raised concerns about the impact in terms of waste of paper and resources to truck the massive volumes around the nation, while investors questioned the huge amounts of financial resources required to design, print and ship a high cost glossy guide, and whether it would show an acceptable return on investment.
Early indications of the stock price seem to indicate that business has shrugged of these concerns with the trading band of $55 – $75 broken as the share price soared to levels above $85 with the most recent close of $90.
This report looks at the business model and financial fundamentals behind the glossy Restoration Hardware success story to see whether there is a company on solid foundations behind it.
The Business Model
If you can find it in your home, chances are that Restoration Hardware sells it. The company is a pure play traditional retailer, so is one of the simplest business models to understand. It designs, sources and manufactures home-wares and furnishings, before applying an acceptable mark up and selling it through its network of 70 stores throughout the United States and parts of Canada.
The company is vertically integrated, which means it has a large amount of say in the design of its products, and also updates it’s range regularly to reflect changes in fashion, designs, season and trends.
The point of difference is that unlike a Wal-Mart or Best Buy, Restoration Hardware (RH) actively targets the more “premium” end of the market. The strategy is a lower-volume, higher quality and therefore higher margin one. However, it also comes with a higher margin of error as products need to be representative of consumer needs at any given time and the company trades on its good reputation and brand name.
To pursue this strategy Restoration Hardware has a range of Design Galleries to complement their store offerings. These galleries show model homes or inspiration in full scale to entice buyers to imagine the company’s offerings in their own home.
Restoration Hardware also has minor operations in Baby & Child lines, which targets baby and nursery rooms and fittings, as well as a fledgling online sales offering.
The Financial Metrics
The most recently reported financial results painted a picture of a company whose strategy is paying off.
Headline revenue was increased 22% from the previous corresponding quarter to $366.3 million, in what is traditionally the slowest trading period, after Christmas, and where heavy discounting typically has a negative effect. The gains also locked in increases in revenue made in the previous year of 38%, which means that over the two years revenue growth was over 50% in a challenging market.
The truly stunning numbers though, however, were in the operating income, where profits increased 204% compared to the same period in the previous year. The result was somewhat distorted because the previous year comparison was off a very low base of only $0.5 million but was still reassurance that the change in strategy was working.
The results indicate strong momentum, especially in an established and mature industry and at a time when not all of Restoration Hardware’s target market are spending freely.
The Investment Case
The investment case for Restoration Hardware (RH) is largely based on whether they are able to continue to execute their mass-market / premium strategy blend. On the one hand, they are focused on a very tight market niche, but to grow earnings will have to build either their reach or appeal.
For example, their tiny number of stores, around 70, severely limits the number of potential customers they can reach. And unlike clothes or electronics, research shows that customers still prefer to see home furnishings and large items of furniture in person before committing to purchase. The company has recognized this, and has targeting over 30 new locations for stores, increasing their store footprint substantially.
They are also building up their additional stores, looking at ways to expand and add more floor space to their existing locations. They are also looking to cross-sell their products by adding the baby and nursery aspect to the company business model, which could be a revenue driver going forward.
The risk to the company also comes from it’s limited size and reach, which increases the cost of doing business as economies of scale are harder to achieve. There is also the risk that when targeting a small market that the fashion or trends change faster than the company can respond causing customers to leave and / or the company to discount severely to move outdated stock. Both actions severely erode profit margins, especially when earnings are comparably small compared to larger competitors like Macy’s and Ikea.
Restoration Hardware’s strategy of targeting the premium end of the market with customized and fashionable home-wares has paid off handsomely, but future earnings growth will depend on the success of the attempts to add scale and reach to the business as well as cross-sell products to the existing customer base.