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Restoration Hardware Hits New High With Grand Designs

By: Investor's Business Daily
Posted: 6/27/2014 6:08:00 PM
Referenced Stocks: WMT;SPLS;RH;WSM;BBBY

Restoration Hardware CEO Gary Friedman doesn't always move with the rest of the shopping crowd.

As retailers fromWal-Mart Stores ( WMT ) toStaples ( SPLS ) are upping the number of small-format stores, he plans to scrap some smaller stores in favor of bigger ones, including Full Line Design Galleries of 25,000 to 60,000 square feet for the luxury home furnishings chain.

The move to larger stores reflects what Friedman calls a "real estate transformation" atRestoration Hardware ( RH ), a 2012 IPO whose stock hit a new high Friday.

A day before, the company opened RH New York, a three-story, 30,000-square-foot gallery -- triple its prior size -- in a 19th-century building on Broadway in Manhattan's Flatiron District. Antique mirrors flank a staircase with iron handrails, conjuring an Old-World vibe for Restoration Hardware goods, which range from a $99 linen-bordered Turkish cotton robe to above $20,000 for a Cambridge Leather U-Sofa.

After ups and downs with its high-end approach stretching back to the 1990s -- including store closures and being taken private in 2008 -- Restoration Hardware is living its own restoration with a honed strategy, at a time luxury is selling well.

It now operates six Full Line Design Galleries among its many other stores. Once the transformation is complete in North America, "we believe we will deliver $4 billion to $5 billion in annual revenues, achieve mid-teens operating margins and generate significant free cash flow," Friedman said on the June 11 first-quarter conference call.

While many retailers, busy shoring up a presence online, have cut emphasis on catalogs, Restoration Hardware has launched massive new Source Books to complement its stores as showcases for its brand.

Buyers Need A Bookcase

Restoration Hardware once caught criticism for sending huge catalogs. But it has moved from mailing Source Books 10 times a year to once a year, reducing pages circulated as a percentage of sales by about 70%. The new Source Books top 3,000 pages across 13 books.

"Our approach into direct channel mirrors our real estate strategy, eliminating multiple smaller stores in a market with redundant assortments in favor of one significantly larger store with a more dominant offer," said Friedman on the call.

The changes are part of sweeping transformation efforts that also include expanding the company's product line as well as revamping its supply chain and system platform. So far it's helped vault Restoration Hardware to the top of its game with industry-leading same-store sales, and strong performance in a tough retail milieu.

The company has produced four straight quarters of double-digit percentage or better profit growth. In the first quarter of fiscal 2014, earnings rose 200% to 18 cents a share. Sales surged 22% to $366.3 million.

Comparable brand revenue, which includes its direct business, rose 18% vs. a year earlier on top of 39% last year, representing an "industry leading" 57% increase over the two-year period, said Friedman.

Profit And Style

The company upped its 2014 revenue growth guidance to 20% to 22% from its prior 18% to 20%. It raised adjusted EPS guidance to a range of $2.24 to $2.30 from its prior $2.14 to $2.22. Analysts polled by Thomson Reuters see 2014 rising 35% to $2.31, a 25% increase in 2015 and a 27% rise in 2016.

"RH remains one of the most exciting long-term growth stories in our coverage, and we are encouraged to see strong momentum continuing into 2014," said KeyBanc Capital Markets analyst Bradley Thomas in a report following quarterly results.

Why is it an exciting growth story? "Their product is clearly resonating from a style standpoint, and that's evidenced by the 18% comp the company posted in the first quarter and the fact that the company has posted double-digit comps for four years consecutively in excess of 25% (in terms of) comparable brand revenues growth not only in retail same-store sales, but also including the direct channel," Thomas told IBD. He adds that there aren't many growth stories in his broad coverage of furniture and furnishing retailers.

Wells Fargo analyst Matt Nemer concurs: "Product, that's really the driver of everything. Their product expansion has been dramatic."

Catalogs reflect that. The 2014 Source Books, which debuted in May, are 13 books totaling around 3,200 pages, up from six books and 1,200 pages last year, Nemer notes. Of the 13 books, six are new editions of 2013 issues, which he used to gauge the magnitude of new items.

"Restoration Hardware's key strategies (have) been to increase the breadth and depth of the product assortment in both new and existing categories, which is a key driver of brand sales growth," he wrote. Recent adds to the product lineup include "objects of curiosity" -- an assortment of objects and art curated by artisans and collectors -- and a tableware collection.

Tableware, says Nemer, is "an important category that opens the door to wedding registry." Also on tap is RH Kitchen, which he expects will launch by early 2015.

The real estate metamorphosis involves transforming the store base from legacy stores of about 7,000 square feet to stores of 20,000 to 50,000 square feet, says Thomas.

"The intent of Restoration Hardware is to have one great store in every market," he said.

New England To Points West

Restoration Hardware's newest gallery, in Manhattan, is not a Full Line Design store. But just to the northeast in the Wall Street bedroom community of Greenwich, Conn., the company in May opened a 23,000-square foot Full Line Design Gallery in a historic post office on tony Greenwich Avenue. That follows full-line store openings in 2013 in Indianapolis and Boston, in 2012 in Scottsdale, Ariz., and in 2011 in Los Angeles and Houston.

"It's in the early innings of this transformation," said Thomas. "The goal going forward is to find a great location that could be in one of two or three Class A malls in a city or standalone locations."

Restoration Hardware plans a new larger Full Line Design Gallery on Melrose Avenue in L.A. and its first "next generation" Full Line Design Gallery in Atlanta this year. In all it's signed leases for six next-gen large-format stores and is in negotiations for more than 25 others. As of May 3 it also had 61 Galleries and three Baby & Child Galleries, plus 17 outlet stores in the U.S. and Canada.

Friedman says the company has the opportunity to operate Full Line Design Galleries in 60 to 70 North American locations. Thomas says ultimately it can operate about 50 of the larger stores and may have 20 to 30 in smaller formats for an added presence in affluent spots such as the Hamptons on Long Island.

Luxury Looks Up

Restoration Hardware's furniture, lighting, textiles, bath product, outdoor, tableware and children's furnishings are aimed at the affluent consumer.

"The higher-end consumer is healthier than the lower-end consumer, and the home furnishings space continues to be a very healthy category," said Nemer. "Clearly it's helping."

Those factors have been a "light tailwind" driving the company's strong comparable-brand growth, he adds; the main driver is what's happening at the business level.

"We are very bullish on their long-term outlook, and part of that is driven by the fact that more new products are coming," he said. "We're only about 10% through the real estate transformation, and the new larger stores drive significant growth in sales per square feet and sales online."

Restoration Hardware holds the highest Composite Rating -- 98 of a possible 99 -- in IBD's Retail-Home Furnishings industry group. Fellow luxury home goods chainWilliams-Sonoma ( WSM ) comes in next with an 89. Williams-Sonoma and Restoration Hardware are the second and third largest in the group by market cap afterBed Bath & Beyond ( BBBY ). The group also includes traditional furniture sellersHaverty Furniture (HVT) andEthan Allen Interiors (ETH).