Restoration Hardware’s Growth Inflection
For the last several years, Gary Friedman, CEO of Restoration Hardware (NYSE: RH) has spoken cautiously about the housing market, the economy, and demand trends across home goods categories - particularly during the post-Covid hangover after the major surge in 2020/early 2021, and particularly in the luxury housing market.
In this post, we follow-up on our prior post about RH's buyback in June/July with our early look at RH's significant brand "relaunch" with significant new assortment available to customers across its core Interiors collection, as well as its new Contemporary line and its Modern line. The company expects this relaunch to drive an inflection in growth over the coming quarters.
The Relaunch
RH repurchased 17% of its shares last quarter - a massive deployment of capital and a large bet on future earnings growth. Gary's comments on RH's September earnings call communicate exactly what they are thinking - that this buyback will be highly accretive for shareholders in relation to the company's earnings power over the next couple of years.
We communicate our intentions with every kind of buyback. We still have open to buy and the buyback, I think, a few hundred million. And so yes, I think we made a relatively aggressive move here. And it's -- and we think we bought the 17% of the business at a really attractive price. And I think our shareholders are going to benefit from that. And if we're right with our view of the next couple of years, it's going to look like a really great investment. How aggressive will be in future quarters? I think you've looked at us historically, we're kind of opportunistic.
We're not like a big corporation that sets up a regular buyback every quarter and stuff like that. I mean if that was so smart to do, Warren Buffett would do it, right? Warren Buffett is a very opportunistic, repurchaser for their stock. And we're trying to be opportunistic investors, whether it's in our stock, whether in anything that we do. So we think this was a great time to deploy capital and buy back a meaningful position in our company. And it depends what the market does, depends on what we see and how we feel what we'll do in the future.
- Gary Friedman, September 2023
Why did Gary and the RH board think it was such a great time? It wasn't because of current results, which were pretty poor: revenue declined -19% y/y. Instead, Gary was looking to the future - the "relaunch" of RH with new and upgraded collections, products, and gallery aesthetics.
As an example, below are some photos of RH's refreshed designs and how they are shown in the galleries. The brand is transitioning to lighter and more natural tones.
In contrast, below are what the "old" RH looks like. Still nice, but darker tones.
RH's old products are still high-quality and nice, but they hadn't been refreshed since before Covid and they have begun to look a bit tired. RH paused a lot of its new product launches due to the demand surge in 2020 and the upstream supply chain bottlenecks that happened in late 2020 into early 2022. Additionally, all furniture retailers had to contend with significantly higher logistics costs, particularly ocean freight container rates which rose about 10x above pre-Covid levels. Those higher costs got embedded into retail prices across the furniture ecosystem, which pushed up prices and hurt transaction volumes across the industry due to tougher affordability. This left RH with older product lines that were more expensive than ever and a reluctance to launch significant new products at very elevated prices. Some customers were willing to pay those prices during the peak work-from-home period, but after that surge cooled off, RH was competing in a pressured market with older product.
To see what RH expects in the future, Gary's comments about the source books and product refresh from RH's most recent call tells the story:
So we've got this first contact that will get all in-home kind of, call it, end of September, first week of October. And then we're going to come out with the contemporary book kind of mid-October through late October and then we'll come with the January book with the contemporary book in the October period and then the modern book in early January when people get back from holidays and so on and so forth and everything reopens again.
Then we'll cycle back around, and we'll hit everyone with this next contact, if you look at over a 12-month period and that will be kind of a March, April, May, June contact. And so the 3 books we'll hit again will have another meaningful round of newness coming. And by the end of that contact, we will be kind of fully transitioned. It doesn't mean we won't have new product in the next contact when you think about the next fall. But the percentage of newness will be more in the 15% to 20% range, where this is basically an 80% refresh of the brand. It's massive. It's the biggest product move I've ever made in the history of my career, and I've made some pretty big product groups.
- Gary Friedman, September 2023
To recap, this cycle is getting 80% newness, whereas a more normal cycle is 15-20% newness. This introduces opportunities and risks, but on balance, we think it's fair to assume they are keeping the best performing and most popular items, and refreshing the brand with new styles and collections which should outperform the older, worse performing items. Over the next year, this should create a strong same-store tailwind for RH. However, in the near-term, RH is discounting to sell its discontinued inventory stock which temporarily may result in lower ASPs and worse margins. Additionally, when new products are introduced, it takes a while for the supply chain to ramp up to enable shorter delivery times. There is a time lag between when they are ordered and when they are recognized as revenue (revenue is recognized on delivery to the customer, not on the order).
Finally, it’s worth noting that the refresh is not just about new styles – it also involves improvements in quality and materials. Many of RH’s new product lines are manufactured with the best materials at the highest standards. This quote from the newest Interiors source book tells the story best:
We value people of incredible talent and integrity. We value great design and quality. We value time, theirs, yours, and ours, and believe it is our most valuable asset and the ultimate luxury.
It’s why we’ve built a platform for the most talented designers and the highest quality manufacturers in the world. Why we use the finest European and American White Oak or Walnut and Indonesian Teak when fashioning and finishing our furniture. Why our sofas are predominately Made in America with eight-way hand-tied springs (considered the gold standard), or Made in Italy with engineered foam and exquisite tailoring to ensure a superior sitting experience that will last a lifetime (we guarantee it).
There are certain things that are inexorably linked to certain spots on the globe, that just aren’t bona fide without the customs stamp to prove they came straight from the source. It’s no accident that the word “original” contains the word “origin.” It’s why we get our Linen from Belgium, our Bedding from Italy, our Toweling from Turkey, and our cotton from Egypt and the US of A. Their trust has been earned over centuries, and we believe their work is worth our time.
The source book highlights these features, as shown below (Introducing Bella, Made in Italy):
RH has continued to elevate its products in style, materials, and build quality, and the company is now aiming to bring a “disruptive” value proposition that will gain market share – even in a weaker macro environment.
Progress So far
Over the last month, we have been tracking pricing and delivery times for a variety of SKUs featured in the new Interiors source book across a few different categories. It's not comprehensive, but it does appear to be representative. We've seen significant improvement in product availability and delivery times, indicating a strengthening ramp of the supply chain and logistics infrastructure around the new Interiors collection.
This is a great sign that the company will successfully capture the demand generated from its massive product refresh cycle. It's important that they get this right because the launch of RH Modern in 2016 created significant disruptions to the supply chain which pushed out delivery dates for orders. It was a terrible experience for customers and for the company. The opposite trend is happening this time.
Having the product available online and viewable in the mailed source books is a great start, but the company also is in the midst on a three-phase process of refreshing its large-format Design Galleries. The pictures above show the refresh of the company's Marin gallery, which is closest to the corporate headquarters. The first phase should be completed in December, the second in February, and the third in the Spring. Refreshing galleries involves some cosmetic changes to the galleries (in many cases, repainting them) in addition to updating the assortment shown on the floor. Each gallery is outfitted differently based on demand patterns in their areas, with many popular items in each zip code earning their way into the galleries.
RH is making some big, bold bets in this period. First, it is doing a massive product refresh - bigger than anything it's ever done before. Second, it invested $1.2 billion of cash into its own stock ahead of this brand relaunch. Gary is famous for making big, bold bets - and for generally getting them right when he bets big. This is what he had to say on what he expects from the bet (he said "inflection" a lot on the call):
Product elevation. We recently mailed our new 604-page RH Interiors Sourcebook, and while it's too early to read the response with only 40% of the mailing in-home this week. The early indications do look promising. We continue to expect our business trends to inflect in the second half of this year with the mailing of our RH Contemporary Sourcebook in late October and our RH Modern Sourcebook in early January, as well as the refresh of our galleries over the next several quarters. We believe our inflection point will peak in the first half of 2024 as our new collections fully ramp and we begin another cycle of Sourcebook mailings, completely transforming and refreshing the assortment across the entire brand over a 12-month period.
The early, early indications. Now you got to be careful and how you extrapolate that, because you have to extrapolate it on, okay, what does this look like when all the books get in home, what does this look like when the in-stocks reach their best -- their optimum levels, what does this look like when you start refreshing the galleries in the stores with those? There's all lift factors to all of that. So when we look at this and we extrapolate this, we think there's going to be a real inflection point. How big is that inflection point? It's -- to us, it looks like a meaningful inflection point.
- Gary Friedman, September 2023
Closing
Brands that deliver stylistic value to consumers are subject to fluctuations around product refresh cycles. If BMW didn't refresh its 3-series for 10 years, there's no question that it wouldn't sell as well. The series of Covid-related discontinuities helped RH’s financial results on the front end, but hurt the company operationally on the back end with regard to the availability, volume, and cost of new products, which contributed to the company delaying the bulk of its "newness" until this current refresh cycle. Now that it has begun, we expect to see meaningful improvements in demand. Because of the longer lead times on newer inventory (though they are improving), revenue acceleration likely will be one to two quarters behind the demand acceleration.
At an average repurchase price of $295, we believe Gary was happy allocating capital at a mid-single digit multiple of future earnings "in the next couple of years." With RH's Design Gallery construction pipeline in process and the contribution from product refreshes on same-store sales, we believe RH is poised to accelerate its revenue and earnings growth over the medium-term. Despite the recent volatility in the stock, the company is pursuing many different growth strategies (international expansion, US gallery growth, hospitality tangents, and product refreshes), all of which should contribute to growing the brand meaningfully over time.
