Is RH’s Turnaround Story Too Good to Be True?

It’s always difficult for hard-hit companies to recover from tough conditions, and many of those that suffer substantial declines in their respective businesses never manage to get back to their former glory. That definitely hasn’t been the case for luxury home furnishings retailer RH (NYSE: RH), as the company that used to be called Restoration Hardware has bounced back from near-disaster to survive and thrive with a new business model and an emphasis on its most lucrative target customers.

Coming into Tuesday’s fiscal second-quarter financial report, RH investors wanted to see more of the same from the retail success story. RH’s numbers showed continued progress, but the results weren’t quite good enough to silence those who wonder whether the retailer’s growth trajectory will be as resilient as bullish investors hope.

Image source: RH.

RH presses onward

Restoration Hardware’s second-quarter results once again told the tale of a company working hard to move in the right direction. Sales were higher by just 4% to $640.8 million, which was well below the $660 million consensus forecast among those following the stock. Yet net income soared to $64 million, reversing a year-ago loss. Even after adjusting for some favorable one-time items, adjusted earnings came in at $2.05 per share, well above RH’s previous guidance for between $1.70 to $1.77 per share on the bottom line.

RH was very happy about how its fundamental business metrics have continued to improve. Comparable brand revenues were higher by 5% from year-ago levels, despite the fact that inventory reduction efforts in the year-earlier period reduced comps by 3 percentage points. Moreover, revenue managed to rise despite a higher proportion of sales from RH outlet locations and the company’s efforts to come up with a leaner, higher-demand lineup of available products.

Margin performance was quite strong. Adjusted gross margin jumped 8 percentage points to 42.1%, while adjusted operating margin nearly doubled to 12.3%. Even more impressive was the fact that operating margin was hurt by new accounting rules that require more rapid recognition of advertising expenses, which RH argued cost the company about 1.5 percentage points.

CEO Gary Friedman once again passionately discussed his vision. “It is clear that prioritizing earnings versus revenues this past year,” Friedman said, “made it possible for us to see opportunities throughout our business that would have otherwise gone unnoticed.” The CEO explained that it makes no sense to go after low-quality revenue, and instead RH will capture high-return sales opportunities that can produce the best bottom-line results.

What’s next for RH?

RH is optimistic about its expansion moves. Later this month, the company will open key gallery locations in New York and Napa Valley, with Friedman seeing “the rare opportunity to create what we believe will be the most innovative new retail experience in the world” in New York at the same time that the location in Yountville, California, will give customers “a unique and immersive experience” in the heart of wine country. Longer-term, future moves to boost its presence in interior design could pay off for RH.

RH also has a flair for the dramatic. In what would normally be a fairly pedestrian discussion of call center networks, Friedman pointed to the opening of a “customer Delight Center” at RH HQ. Placing the center there will “ensur[e] the voice of the customer rings through the corridors of our corporate campus daily.”

Reflecting its optimism, RH once again boosted bottom-line guidance. Earnings for the year should now come in between $7.35 and $7.75 per share, up by almost $1 from previous projections. However, RH cut its revenue guidance by 2%, again reflecting the emphasis on earnings over sales. The retailer also increased its third-quarter and fourth-quarter earnings estimates by roughly 6% to 10%.

RH investors didn’t seem entirely satisfied with the revenue shortfall, and that likely played a role in the stock’s falling 8% on Wednesday morning following Tuesday evening’s announcement. Yet if earnings can continue to grow at the pace that RH expects over the long run, then any short-term drop in the share price could open the door for bullish investors to look even more closely at the luxury home furnishings retailer.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends RH. The Motley Fool has a disclosure policy.

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