Restoration Hardware (NYSE:RH) is the fifth best performing IPO over the last 12 months, up 185% since November 2, 2012. On June 14 it upped its 2013 guidance causing its stock to rise more than 5% on the news. Trading well over $72 (IPO price $24), it seems improbable that the retail design business, which was down and out as recently as 2011, can continue its ascension without some sort of correction. Has it come too far, too fast? I'll explore this conundrum.
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Not The First Time
This isn't Restoration Hardware's first time going public. It did so once before in June 1998 at $19 per share. Its first-day return 15 years ago was a gain of 38%, 800 basis points higher than its second kick at the can last November. With such a fantastic start I'm sure investors back then were just as enthusiastic as investors are today. But it's important to remember that the good times didn't last. By the end of its second fiscal year as a public company it went from an operating profit of $3.9 million in 1998 to an operating loss of $4.8 million in 1999. Over the next eight years it lost a total of $137.1 million through fiscal 2007. Ultimately it was sold to private equity firm Catterton Partners for $175 million in cash and the assumption of $111 million in debt. Given its current stock price, Catterton's made out like bandits.
It's Come A Long Way
Catterton paid 0.24 times revenue to acquire Restoration Hardware in 2008. Today it's trading at 2.1 times revenue, almost 10 times its P/S valuation five years earlier. Management's recent upping of its 2013 revenue guidance from 21% projected growth previously to 25% growth year-over-year suggests an $83 stock price by the end of fiscal 2013 next January; however, that's without any expansion of its P/S multiple. Zacks recommends three other stocks in the home furnishings and fixtures sector: Fortune Brands Home & Security (NYSE:FBHS), Haverty Furniture (NYSE:HVT), and Kirkland's Inc. (Nasdaq:KIRK). The average P/S multiple of all three is 1.1, almost half Restoration Hardware's. Certainly, its revenue growth is much higher than its peers justifying a higher multiple from a that standpoint. On the other hand, even if it hits its 2013 adjusted EPS of $1.47, it will generate an operating margin around 6.1%, only slightly higher than its three peers and far less than Williams-Sonoma's (NYSE:WSM), which is in double digits.
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There are two things that positively impact its business: First, it made the decision a couple of years ago to open full-line design galleries that are 21,500 square feet, three times the selling space of its legacy retail locations. With five open as of the end of April, it plans to put bigger stores in 50 markets across the U.S. and Canada. With negotiations well under way in 30 locations, the company is moving from a sales-oriented business to that of a design firm in a move very similar to that of Ethan Allen (NYSE:ETH). Secondly, it continues to build a large chunk of business online. Customers go into the store to check things out and then order the products from home. In the first quarter it grew direct revenues by 38% to $142 million accounting for 47% of its overall revenue. If Restoration Hardware is able to successfully profit from e-commerce as Williams-Sonoma has, its future will be very strong indeed. Current results would seem to indicate it's going in the right direction.
I really like the direction of its business. Its move to capture the design market differentiates itself from other furniture retailers. However, the recent introduction of two new businesses involving antiques and tableware has me a little concerned that it's stretching its wings before it's had a chance to perfect its larger retail footprint. Early results, while encouraging, doesn't necessarily mean it can execute in 30 stores as efficiently as it does in its five existing locations.
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Restoration Hardware's past is a checkered one. That said its business model in its current configuration appears to be a winner. By opening bigger footprint locations as both the housing market and the economy are improving, it's riding a wave that doesn't appear to be slowing anytime soon. While its valuation is extremely frothy at the moment, a long-term investment over 2-3 years should deliver suitable returns unless it's unable to execute its transformation to a larger footprint. That answer we won't know for at least four quarters, probably more.
Has it come too far, too fast? Probably. However, if you have a long-term horizon, I'd consider buying some now and holding cash to buy more in the future once its stock has dipped below its current price.
At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.