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Why RH’s Net Margins Fell in 2Q17

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2Q17 margins

RH (RH) posted an adjusted gross margin, an EBITDA (earnings before interest, tax, depreciation, and amortization) margin, and a net margin of 33.2%, 9.1%, and 3.2%, respectively, in 2Q17. These margins were at 33.7%, 8.6%, and 3.3%, respectively, in 2Q16.

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Factors that affected RH’s margin in 2Q17

During the quarter, the company’s adjusted gross margins fell 0.5% due to the reduction of revenue and incremental expenses linked with the product recall and the amortization of inventory at fair value adjustments related to the acquisition of Waterworks. Also, the company deleveraged due to inventory optimizing efforts and increased sales from promotions and higher discounts.

Despite the fall in gross margin, the company’s EBITDA margin rose 0.5%. The expansion was mainly driven by leverage from employment and employment-related expenses and lower corporate occupancy costs. However, some of the expansion was offset by increased advertising and marketing expenditure.

Compared to 2Q16, RH’s adjusted net margins fell 0.1% due to a rise in interest expenses and the effective tax rate. Compared to 2Q16, the interest expenses rose 0.3% to 2.4% of the total revenue in 2Q17, while the effective tax rate in 2Q17 stood at 39% compared to 37.7% in 2Q16.

Peer comparisons

During the same period, Williams-Sonoma (WSM) posted a net margin of 4.4%, and analysts are also expecting Bed Bath & Beyond (BBBY) to post a net margin of 4.4%.

Outlook

For the next four quarters, analysts are expecting RH to post gross margin, EBITDA margin, and net margins of 35.2%, 9.9%, and 3.3%, respectively. In comparison, in 2Q16, these margins were at 32.7%, 7.8%, and 2.5%, respectively. Analysts are expecting the new membership model, the redesigning of its distribution network, and optimizing of its inventory to improve RH’s margins in the next four quarters.

Next, we’ll look at RH’s 2Q17 EPS.

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