RH’s 23.3% return over the past six months has outpaced the S&P 500 by 18.2%, and its stock price has climbed to $329.50 per share. This run-up might have investors contemplating their next move.
Is there a buying opportunity in RH, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
We’re happy investors have made money, but we're swiping left on RH for now. Here are three reasons why we avoid RH and a stock we'd rather own.
Why Is RH Not Exciting?
Formerly known as Restoration Hardware, RH (NYSE:RH) is a specialty retailer that exclusively sells its own brand of high-end furniture and home decor.
1. Shrinking Same-Store Sales Indicate Waning Demand
Same-store sales is an industry measure of whether revenue is growing at existing stores, and it is driven by customer visits (often called traffic) and the average spending per customer (ticket).
RH’s demand has been shrinking over the last two years as its same-store sales have averaged 8.2% annual declines.
2. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, RH’s margin dropped by 18.9 percentage points over the last year. This decrease came from the higher costs associated with opening more stores.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
RH burned through $395.5 million of cash over the last year, and its $3.82 billion of debt exceeds the $87.01 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the RH’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of RH until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
RH’s business quality ultimately falls short of our standards. With its shares outperforming the market lately, the stock trades at 31.6× forward price-to-earnings (or $329.50 per share). At this valuation, there’s a lot of good news priced in - we think there are better investment opportunities out there. Let us point you toward one of our top digital advertising picks.
Stocks We Would Buy Instead of RH
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