NOTE: the following analysis on why RH is overvalued and is a great short is from the latest issue of my short selling newsletter. To learn more about it follow this link: Short Seller’s Journal
The economics that drive RH’s business is the housing market cycle – not the brown, smelly organic cow pasture material that exhales from the CEO’s mouth.
RH (RH – $446) – A way to short both the housing market and the trend of declining consumer spending on discretionary items is RH, formerly known as Restoration Hardware. RH is an upscale home furnishings retailer that sells its products through retail stores, catalog and online. It pretentiously refers to its stores as “galleries.” It operates 70 galleries, 18 full-line design galleries and 3 baby/child galleries. RH designs its furniture and accompanying products and refers to its furniture gallery offerings as “collections.”
I’ve been tracking RH for several weeks and have been looking for an opportune time to present it in SSJ and invest in puts on the stock. The stock soared $64 (17%) on Friday after the Company reported its FY Q3 financials Thursday after the market closed. Although the Company missed consensus revenues and EPS for the quarter, the Company issued unexpectedly robust guidance for its FY 2024 Q4 and full year for revenues and profit margins.
The CEO of RH is known for his long-winded, flamboyant – if not pretentious – quarterly shareholder letters that are full of grandiose assertions about his vision for RH. Of course they are also notable for lacking specifics with respect to execution. Here’s an example from the latest quarter: “We have worked hard to destroy the former version of ourselves and are in the process of unleashing what we believe is an exponentially more inspiring and disruptive RH brand, inclusive of the most prolific product transformation and platform expansion in the history of our industry.” There’s two pages of that crap.
For its FY Q3, revenues rose 8.1% YoY ($811mm vs $751mm), operating income nearly doubled ($101mm vs $51mm) and net income swung from a $2.1mm loss to income of $33.1mm. This compares to FY 2023 Q3 in which revenues declined YoY. Speaking of which, FY Q3 2024 revenues were 6.7% below FY 2022 Q3 revenues and operating income plunged 40.5% from 2022 Q3 to 2024 Q3. This shows the degree to which RH’s revenues and profitability correlate with home sales.
With respect to the YoY quarterly increase in revenues for Q3, this does not surprise me. New home sales in the three month period for August – October in 2024 were moderately higher than for the same period in 2023. In addition, RH rolled out a new Sourcebook in July this year, just in time for its FY Q3, which featured its new, aggrandized “collection” of furniture. In my opinion, there was likely a “new car model” effect that occurs when an auto OEM rolls out a new or updated model. Plus there was a bump in revenues from price inflation. Given those three factors, particularly the fact that new home sales rose YoY during RH’s FY Q3, an 8.1% YoY increase in revenues YoY is not impressive. It also suggests to me that there’s a good chance that RH will miss its Q4 guidance.
This graphic below further illustrate the correlation between RH’s revenues and share price to new home sales:
Though the two graphs are on a different scale, it’s easy to see the directional correlation between RH’s stock price and the volume of new home sales from late 2019 to now. The two charts moved in opposite directions in mid-November, as RH started to melt-up, a week before the new home sales report for October was released showing a 17.3% drop in sales from September. At some point I anticipate that both charts will re-correlate, with RH catching down to new home sales. I also found a chart that showed RH’s quarterly revenues going back to Q3 2019. That chart looks quite similar to the two charts above. RH’s share price trended laterally for the most part from June 2022 September 2024. Similarly, RH’s revenues were largely flat from mid-2022 to the latest quarter. Again, the economics that drive RH’s business is the housing market cycle – not the brown, smelly organic cow pasture material that exhales from the CEO’s mouth.
Finally, RH’s share price is extremely volatile. This is because the total amount of shares outstanding is just 18.6mm, while the share float is 15mm. As of the end of November, the short-interest in the shares was 12.1%. This makes the stock vulnerable to squeezes, which is what I believe occurred Friday.
Per the chart above, RH is prone to huge moves higher in a short period of time only to give back the gains. I expect the same thing to happen again, though it may take a Q4 miss of expectations to trigger a sharp sell-off. In addition, the stock is now registering an extreme overbought reading per the RSI.
As mentioned above, I am confident that RH’s Q3 performance vs a year ago is primarily attributable to a higher level of new home sales during the quarterly period this year vs last year. The stock is trading at 128x trailing 12-month earnings. It trades with a forward P/E of 35.8, which is still quite high. I also expect its FY 2025 earnings to be revised lower as 2025 unfolds and as new homes sales continue to trend lower. In addition, keep in mind that the universe of potential customers is declining along with household disposable income.
I have not yet decided which puts I am going to buy or when I will buy them. That said, it will be a longer term fundamental play for me so I will look to go out at least to the May or June 2025 puts. If you short the shares, which I may do instead, I think now is as good of a time as any but I would recommend a stop-loss 15-20% above the current price.