Members can access a PDF of this update here.
RH reported 4Q24 yesterday and today the stock is down -40%. This puts the stock’s YTD performance at -60%.
While RH has always been a volatile stock, this movement is extreme. While attributing stock price movements to specific events is always fraught with imprecision, high level we see three main factors: 1) depressed business activity driven by soft existing home sales, 2) illiquidity risks given their debt maturity in 2028, and 3) tariffs increasing costs and potentially precipitating a global economic slowdown and thus exacerbating the potential for a liquidity issue.
4Q24 Update.
Taking a step back, the 4Q24 results were fine. 4Q net revenues were +10% y/y, or on a comparable 13-week basis +18% y/y (there was an extra week of sales in the comp period).
Total 2024 annual revenues closed at $3.2bn or +5% y/y for the full year.
Operating income was $70mn with operating margins at 8.7%, flat y/y.
They guided full year 2025 revenues to +10-13% y/y with 1Q25 a little better at +12.5-13.5% y/y. Still though this represents a 500-800bps deceleration from their 4Q growth cadence.
Their outlook for adjusted margins of 14-15%, is about 270-370bps better than 2024.
In the letter, CEO Gary Friedman notes that existing home sales were lower in 2024 than in 1978, despite the U.S. having a 50%+ larger population now. He brings this up because when someone buys a home it is a very common trigger event for them to buy furniture to furnish their house.
While macro weakness continued in 2024, they continued to plow ahead with their multi-decade vision of transforming RH. They have plans to open 7 Design Galleries, 2 Outdoor Galleries, and 2 “New Concept Galleries” this year.
Their Paris Gallery on the Champs-Élysées will open in the back half of 2025, which they expect to drive an inflection in their Europe business. In 2026 they will open their London and Milan Gallery, which they think will build on their momentum in Europe. Additionally, they are planning an increase in their presence in Greenwich, Connecticut with a “multi-building design Ecosystem” and potentially something similar in East Hampton.
They will also be releasing a new RH Outdoor Sourcebook that will feature “the most dominant assortment of high-quality outdoor furniture in the world” with 8 furniture collections. Their RH Interiors Sourcebook will feature 42 new collections. These new products require increased inventory and since furniture has long lead times, they wanted to insure against stockouts, which could cause loss of sales. On the call Gary called this a “$100mn insurance” on inventory at the front end of the launch. They also noted that they delayed the launch of some collections due to the “changing economic outlook”.
Tariffs.
The real uncertainty though stems from Tariffs and the potential stress it could add to the business, when they are ~3.5 years out from needing to pay off or refinance $2.3bn in debt.
Providing a modicum of relief, Gary noted that 48% of upholstered furniture was produced in the U.S. with a further 21% coming from Italy. 14% of their total product will be produced in the U.S. by the end of 2025.
This of course still leaves a lot of room for their products to be slapped with tariffs. As noted in their 10-K, 72% of products are sourced from Asia with 35% from Vietnam and 23% from China. Vietnam is set to incur a 46% tariff under the current proposed Trump Tariffs and China’s total tariff will now reach 54% (an increase from 20% prior).
While no one knows for certain whether the tariffs will go into effect (and everyone is hoping they won’t), with a 45% gross margin, and just taking their Vietnam and China produced products, that alone would compress gross margins by 18%. Layering in other Asian tariffs and the “Universal” 10% Tariff, could easily push gross margins down to below 20%. Now this math is very rough and assumes all sales are in the U.S. and subject to tariffs, as well as that the manufacturers do not offer concessions, nor does RH raise prices. While these assumptions are flawed, it helps illustrate the magnitude of how problematic Tarriff’s of this level could be.
Now they can try to source supply from elsewhere, which could provide some relief, but there is no doubt that these proposed tariffs will be highly destructive to margins. RH of course is far from alone in this dynamic and they arguably have a bit more pricing power than peers, but the messaging over the past couple years seems to have been that they need to wait before tapping further price increases (recall Gary Friedman commenting that they were “arrogant” with some of the pricing prior). Having said that, this is a different situation. If tariffs are implemented, then all prices are going up… and a lot.
This all means that if these tariffs go through, RH could struggle to be profitable without a significant rejiggering of their supply chain and increasing prices, which will weigh on volume. Further complicating the manner is the issue of potential reactionary tariffs from other countries. Exactly how this all shakes out it entirely unknown, which is certainly uncomfortable.
On the call Gary Friedman also made a vague reference to a long-term sourcing strategy that is “like a leap frog” vision, but they didn’t want to talk about it until they figured out how to do it. Exactly what that means is up for anyone’s interpretation.
To be clear, RH is just one out of virtually every business that is caught in the trade war crossfire. Nevertheless though, as a seller of nonessential, infrequently purchased, large ticket discretionary items, they are very susceptible to consumers deferring purchases. In addition to the adverse economic impact the tariffs could cause, it could also foment weakness in the stock market, which can further dampen consumer confidence and thus their appetite for furniture.
But it is important to remember that Gary Friedman has had a long career in retail and has had to manage much worse hands before. When he initially took over Restoration Hardware, they had such a bad liquidity crunch that they had to pick which payables to pay and which to ignore, literally managing their cash on a day to day basis.
For more background on the multi-decade “turn around”, read the below excerpt from our 2Q23 Business Update:
RH started life as a specialty retailer of hard-to-find antique hardware (think Victorian doorknobs and vintage wooden chests), but the slow-moving nature of such products and their lack of ability to advertise to draw foot traffic, pushed Stephen Gordon to add an eclectic mix of cheap tchotchkes (think mini guitar Christmas ornaments, dog bone shaped cookie cutters, and games like the “Mr. Wizard Science Set”).
He rightly figured that a higher frequency item (cheap gifts and novelties) would increase store traffic and he hoped that this would help keep Restoration Hardware “top of mind” so a customer thought of them when they were in the market for a lounge chair or bed. However, instead Stephen Gordon faced the King Midas problem: they increased traffic at the cost of decreased conversion. The weird and cheap items marred their image as a quality home goods retailer; few consumers would shell out $2k for an antique chest that was adorn by toys and Moon Pie snacks. They may have been successful in drawing a steady stream of looky-loos, but after the novelty wore off, same store sales slowed and an aggressive expansion left them near bankruptcy.
It was at this time, in 2001, that Restoration Hardware’s turnaround leader, Gary Friedman, became CEO. The turnaround of Restoration Hardware is perhaps one of the most underappreciated turnaround stories in business history. The stores were literally selling dog food and now they have in-store restaurants that generate over $10mn a year in sales. Their entire footprint was cookie-cutter box stores in traditional malls and now they occupy ornate, museum-like Galleries that can exceed 70,000 square feet. When Gary Friedman started at Restoration Hardware, he walked away from a $50mn option package at William-Sonoma and instead used his savings to participate in a desperate equity-injection to stave off imminent bankruptcy of a failing retailer. Maybe you thought Elon Musk trying to build the first new successful American car company in a century or create reusable rockets was crazy, but in the brutally competitive world of retail, Friedman trying to turn a floundering, broken box-store concept into a luxury retailer is just as crazy.
As Gary reminded investors in the letter, he is very good at monetizing retail space. He notes that they took a store that did $2mn in sales and after reenvisioning the space, grew it to $44mn with the exact same square footage. In the world of retail, that is an extremely hard—and essentially unheard of—feat.
Liquidity.
The real risk, in our opinion, is less that RH doesn’t achieve what they set out to, but that the current shareholders don’t get to come along for the ride. This could be because they have to do a highly dilutive equity offering, go private at a low valuation, or in a worse case scenario, the debt holders take control. Now all of these possibilities are very remote, but when a company has $2.3bn in debt due in ~3.5 years, it’s not impossible—which is what is likely what’s spooking many investors.
One of the more telling lines in the letter was when Gary mentioned their debt in tandem with their $500mn of real estate and $200-300mn of excess inventory. This is the first time he’s mentioned monetizing assets in the context of paying down debt, seemingly anticipating investor concerns.
They currently have $1bn in inventory on their balance sheet, which is ~$270mn higher y/y. As they introduced new collections with new products, they invested in inventory ahead of that to avoid stock outs. But as they see which SKUs are the most popular, they will start to cull underperformers.
In the past, Gary Friedman introduced the idea of horizontal versus vertical inventory. Horizontal inventory is the breadth of inventory a retailer carries, whereas vertical is amount of stock of a given item. New collections essentially mean that the amount of horizontal inventory grows, but not vertical.
This is an important distinction to make because analyst will often look at building inventory as a sign of pending sales slowdown. But that would only be pertinent if it was vertical inventory, which is not the case with their recent inventory build. As they rationalize their inventory, they will unlock more working capital that can help pay down debt.
With many of the galleries they build they will purchase the real estate and later do a sale-lease back. With real estate monetization and unlocking excess working capital they can bring their debt load down to around $1.25bn. While the most likely outcome may be a simple refinancing or issuance of a new note, the potential for a worsening economic calamity invoked by tariffs could mean that banks are reticent to lend, giving debtholders the opportunity to make usurious demands. Again, this is an unlikely outcome, but the fact that it can even be contemplated is uncomfortable.
For now, though, at least Gary does not seem concerned.
Valuation.
In terms of upside, there isn’t a need for any fancy math. At a $150 stock price and with 20.8mn share outstanding, their market cap is $3.1bn, with an enterprise value of $5.5bn without lease liabilities and $6.7bn including them.
A few years ago, their long-term expectations for the North American business was $5-6bn, which was increased from $4-5bn prior. They have also noted that they think their international business could be larger than their North American business in the future.
In terms of margins, they have suggested long-term their they could reach the vicinity of other luxury brands in the 35%+ realm, but their prior peak margins were 25%.
For conservatism, if we assume they do just $5bn in global sales, and apply a 15% operating margin, that is $600mn in NOPAT. If we apply a 20x earnings multiple for an EV of $12bn, that gets us an implied equity value of $9.7bn (not backing out the capitalized leases because the rent is being expensed in the NOPAT figure). If we assume they can reach that by 2030, that is an implied return of 26%. Of course it could take them much longer, but they also could generate much more in sales globally overtime.
A little more optimistically, if they can do $5bn in North America and match half of that internationally, while commanding a 20% margin, then they will be generating about $1.2bn in NOPAT. A 20x multiple would put their implied equity value to above $20bn.
While exactly what mature margins will be or how many billions in international sales they can achieve is too hard to predict, we shouldn’t get too far away from their product and the experience RH provides. When a company can consistently create a unique and differentiated consumer value prop, they will eventually generate the cash flows that reflect that. (For more on mature margins and predications, see our RH Research Report).
Just simply look at all of the galleries and products they are introducing, and it is hard to think that it won’t be well received by customers. Sure, some products will flop, and some designers will complain that they can get similar products elsewhere for less, but the whole RH experience in totality: the Galleries, the ease of using in-house designers, the product breadth, the hospitality, the direct to consumer model, the brand awareness, all of these aspects provide a strong value prop that no one else offers and fit many consumer preferences.
There is no doubt that if they are successful on executing their vision that the upside is there, but the real risk is a worst case scenario of a severe economic contraction being met with $2.3bn in maturing debt.
In a worst case scenario, where they can’t refinance their debt, they may be forced to issue equity at a highly dilutive price. And it is also possible that if the economy sharply slows that they start bleeding cash flow and cannot even complete an equity offering. While these are very draconian scenarios, the stock price moving down so much is likely because investors are contemplating the likelihood of these remote, but capital impairing outcomes.
As we always note, we named our research firm Speedwell after the ship that helped ferry passengers to the Mayflower. The idea is that we want to help you get into the position to take the journey, but ultimately, we are not going to go with you. There should be no illusions—you are on your own with the decisions you make. It is an investors job to judge for themselves whether they believe the potential for profits are worth the potential risks that could materialize.
*At the time of this writing, one or more contributors to this report has a position in RH. Furthermore, accounts one or more contributors advise on may also have a position in RH. This may change without notice.