Insights on Restoration Hardware’s Massive Stock Buyback
Let's dive into the buzz around RH (NYSE: RH), a portfolio company better known as Restoration Hardware, a leading high-end furniture store that has recently made headlines by repurchasing nearly 3.7 million shares in June and July. With a track record of savvy capital allocation, RH's massive buyback spree is worth exploring. In this post, we will unpack their distinctive approach to stock buybacks, compare their strategy with other market leaders, and consider the implications of their latest big move.
Zooming out for a moment, as investors, we want companies to use their balance sheets to enhance shareholder value through astute capital allocation. However, most companies do not do this. There are some horror stories, like Bed, Bath and Beyond, which recently declared bankruptcy but had repurchased $11.8b of shares since 2004. There are other sub-optimal uses of cash, like Apple hoarding hundreds of billions in cash and investing it in low-interest government bonds for many years before it began its buyback campaigns. Sub-optimal, but companies that hoard cash will always live to fight another day.
Then there are recurring capital distributors which occur through programmatic buybacks via 10b5-1 plans. Let's look at one of the poster children of this strategy, Charter Communications (NASDAQ: CHTR), a case study of John Malone’s “levered equity” capital allocation strategy. Since 2016 through Q2 2023, Charter has repurchased 153.1m shares at a total cost of $69.8b (average of $455.91 per share). With the stock currently trading around $400, Charter has, in aggregate, lost money on these buybacks. I wonder where the stock would be if it, instead, paid a regular dividend or deleveraged its balance sheet.
Now, let's pivot to RH, the subject of this post. RH takes an opportunistic approach to capital allocation. The company buys its stock aggressively when it’s depressed, but RH can be dormant when its stock is trading at fair or expensive valuations.
Visually, we can see how much better RH has been at buying its stock than Charter:
Now, what's most interesting about RH is that from mid-June to mid-July, the company repurchased $1.2b of shares at an estimated average price of $330/share. This is a burst of buyback activity that we've really only seen once before - in 2017, when the company was going through a difficult transition in its business model. The company repurchased over 20m shares at just under $50/share. Let's do a quick study of that period to get a sense for what the company was looking at when they repurchased that much stock, that quickly.
Some details on RH’s 2017 buyback:
On estimates before the company began its buyback campaign, it appeared that the company was purchasing its shares at 20-25x the next year's earnings.
What actually transpired was a material improvement in earnings vs. consensus expectations (about 2.5x), on top of a significantly lower share count. The company actually bought its shares at about 7x its reported FY19 (January fiscal year end) earnings.
RH knew how its business was performing. It knew that its internal transformations (transition to membership model, launch of RH Modern, restructuring of logistics and delivery, etc.) were starting to produce their desired results. It took advantage of the market's pessimism and magnified its EPS recovery over the ensuing years. Building on this, below is a great quote from Gary Friedman (RH’s CEO) from March 2020, which explains their mentality around making big moves, what they saw in 2016/2017, and how it can inform us about their strategy today. March 2020 was the beginning of the global Covid lockdowns, when demand trends and supply chains were highly uncertain.
But short term, we've got to get through here and now. And we've got to make sure we, as everybody else do, as everybody else does, we have to live to fight another day. And we have to make a lot of tough, short-term decisions and make those decisions in the context of a strategic view of the future and not screw anything up here by moving in haste and being driven by fear. So we say the facts remove the fear. What do we know? What are the facts? What's the data? How do we think about it? How do we recognize the right patterns? And how do we set up the next 20 moves? If you like playing chess, if you've ever seen the movie Searching for Bobby Fischer? If you haven't, we're all locked down right now at home. I'd encourage everybody to watch that movie. It's about a young boy who plays chess named Josh, and he's trained by a street player and a Russian master. And it gets to the point -- we use it as kind of a leadership training movie in our company. And the final game, if you can actually just Google and pull up the YouTube of the final game, Searching for Bobby Fischer, it's all about don't move until you see it, right? Don't -- see the whole board, don't move until you see it and see the big moves. And if we see those and we make those moves correctly, I think we're going to redefine ourselves in a way that's exponentially greater than we did in '08 and '09. That's exponentially greater than when we redefined ourselves in '16 and '17 when we decided to pull the car in the pits after our kind of rocky start with RH Modern. And we decided to move from a promotional model to a membership model that allowed us to re-architect the entire operating platform of the business and elevate the brand.
The scene referenced from “Searching for Bobby Fischer” is worth watching. It’s hard to watch it without the phrase “don’t move until you see it” repeating in your head. Since this is a leadership training video for RH, clearly this is an important message.
RH raised $2.5b in new debt in 2021 and 2022 and deployed the cash more gradually, repurchasing $1b of shares in calendar 2022. At the end of April, it had $1.5b of cash. So, what can we infer from RH using 75% of its cash to repurchase $1.2b of shares in June and July? What does Gary Friedman see that pushed him to move so aggressively?
Analysts expect RH to produce about $10 of EPS in FY24 (Jan year end), $14.50 in FY25, and $17 in FY26. On this basis, the estimated $330/share it paid is about 20x FY26/calendar 2025. Definitely some echoes to the prior buyback.
The company is paying over 8% on the cash it used to repurchase this stock (raised from its term loans originated in 2021 and 2022). To be accretive, they would have to earn more than that on these repurchases. Let's say 9x (11% earnings yield), which on $330/share would imply $36.67/share of EPS (more than 2x current estimates).
If it were buying at a forward P/E ratio that is similar to its prior 2017 buyback, RH would be anticipating close to $50/share of EPS.
If we believe the company sees $35-50/share of earnings, the stock would likely trade at $700-1,000/share, making its $330/share a great price.
With growth slowing since the Covid surge, how could RH have so much confidence, at this moment in time, to use almost all its excess cash in a very narrow buyback window? It's hard to know specifically right now, but below are some possibilities:
The luxury housing market has experienced worst-ever declines following an incredible Covid period. However, according to Redfin, the luxury housing market has started to rebound. See the chart below for early evidence of a recovery:
2. RH opened its first international Design Gallery in June, at the grand 73-acre Aynho Park estate. This opens up the entire country for business and kicks off a multi-year, multi-country growth effort. RH will open for business in France, Germany, Italy, Spain, Switzerland, Belgium, and more. I doubt the first few weeks of RH England were the catalyst for this buyback, but it is possible.
3. During the Covid-affected years, RH saw a surge in demand and then a retrenching of that surge. During the surge, RH delayed most of its new assortment, saving the "newness" for the post-Covid operating environment that we are in today. This includes its new RH Contemporary line, as well as significant new product in its core product lines (Interiors and Modern). The company could be seeing significant traction and share gains among its newest and best products.
These are just three options, but there are many other options and permutations that could have pushed RH to execute such an aggressive share buyback. We will find out soon enough when the company reports earnings next month.
I believe RH has a clear path to grow the company significantly over the medium- to long-term, pursuing its gallery transformation strategy in the US, capturing additional hospitality demand across its assets, and opening significant new international markets where it has no presence today. The longer-term view should be enhanced materially by the company's strategic and opportunistic capital allocation. Hopefully this post showed why that has been true in the past, and is likely to be true in the future.
