Many individual investors take their cues from Warren Buffett. That’s why it might have been noteworthy when it was revealed that Berkshire Hathaway completely sold off its stake in the luxury furniture retailer RH (RH 3.09%) during the first quarter of 2023. The initial reaction might be to follow Buffett’s actions.
Shares of RH remain under pressure as they’re down 67% from their all-time high. Investors are likely worried about the economic slowdown and its effect on the business in the near term. Taking this into account, this is still a growth stock to consider buying right now, even with Buffett no longer a shareholder.
Let’s take a closer look at why.
Peeking at the latest financial results
RH just reported its fiscal Q1 2023 financials (for the three-month period ended April 29). Although net revenue of $739 million and diluted earnings per share of $1.76 were down 23% and 76%, respectively, year over year, both headline figures exceeded Wall Street estimates for the quarter.
Nonetheless, CEO Gary Friedman called out higher mortgage rates and the Federal Reserve’s tighter monetary policy as headwinds facing the business. This makes sense because when times are tough, customers will be less inclined to spend a lot of money on expensive furniture.
RH will need to implement a greater number of markdowns in order to push discontinued inventory, which will pressure margins. “We will be focused on turning inventory into cash and continuing to optimize costs throughout the organization,” Friedman said on the Q1 2023 earnings call.
The management team still raised guidance for the full fiscal year, now forecasting revenue of between $3 billion to $3.1 billion. Those previously mentioned markdowns, with the addition of a revamped product assortment, should help provide a lift to sales. That confidence is exactly what shareholders want to hear.
The positive attributes of RH’s business
The most recent financial results demonstrate that RH is certainly dealing with a softening macro environment, as is the case with many businesses, especially retailers. But I think investors would gain a much better perspective if they zoomed out and tried to focus on the bigger picture. This will show that RH has some wonderful qualities from an investment point of view.
At a high level, RH is a luxury brand. The company’s focus on the high end of the home furnishings market has resulted in outstanding profitability. During the five-year period between fiscal 2018 and 2022, RH’s operating margin averaged a stellar 17.1%. Wayfair, which serves the lower end of the furniture market, hasn’t produced positive net income on a consistent basis. And in 2022, Wayfair’s net losses ballooned to $1.3 billion.
Another industry rival, Williams-Sonoma, has produced positive profits. Its average operating margin over the last five years was 12.8%. That’s solid to be fair, but it’s still well below RH’s.
This better bottom-line performance that RH possesses is due to its high-end standing. And the fact that its customer base skews toward affluent customers allows the business to be more resilient to economic downturns. Sales have declined by double-digit percentages on a year-over-year basis in the last three fiscal quarters, but the business is still firmly profitable. It has a strong financial standing, with $1.5 billion of cash on the balance sheet and sustainable free cash flow generation.
Moreover, luxury stocks can make for good investments. Just look at LVMH Moët Hennessy or Ferrari, whose stocks have both crushed the S&P 500 over the past five years. Maybe RH is close to being in that exclusive category when it comes to brand power.
There’s also lots of growth potential for RH in the future. Management estimates the addressable market for RH’s ecosystem vision, including products, places, services, and spaces, is worth a whopping $7 trillion to $10 trillion. Commanding a tiny share of this opportunity would result in sizable revenue.
One of the more attractive characteristics about RH right now might just be its valuation. As I mentioned before, the stock is down 67% from its peak, which was set in August 2021. Unsurprisingly, the pandemic boom for the company’s fundamentals, coupled with bullish sentiment from Wall Street, pushed shares to new heights.
But things have obviously taken a downward turn. With the current price-to-earnings ratio at a below-market multiple of 17.6, it’s an easy decision for prospective investors who are looking at buying shares.