RH Earnings: Will Slower Growth Hurt Its Stock?

RH (RH) will announce its third-quarter earnings after the markets close on December 4.

RH earnings: Slower growth ahead

We expect RH’s top and bottom-line growth to mark a sequential decline. Notably, RH’s top line increased 9% in the first half of the year. The company’s revenues increased 7.4% and 10.3% in the first and second quarters, respectively. However, for the third quarter, the revenue growth could decelerate to the mid-single-digits.

RH’s adjusted EPS increased by about 53% and 59% in the first two quarters, respectively. However, for the third quarter, the EPS growth rate could show a sharp sequential deceleration. The EPS growth rate could be lower than half of what the company registered in the first half.

What to expect from RH’s earnings

Analysts expect RH to post net revenues of $676.03 million in the third quarter, which implies growth of 5.9% YoY (year-over-year). Management expects the revenues to mark 5%–6% growth in the third quarter. The growth projection indicates a sequential slowdown compared to the performance in the first half of the year.

Exiting underperforming businesses and closing a 500,000 square-foot distribution center will likely limit the revenue growth rate.

Analysts expect RH to post an adjusted EPS of $2.22 in the third quarter, which implies growth of about 28% YoY. In the first instance, the earnings growth projection looks solid. However, the projected growth rate is lower than half of the company’s growth in the first half of the year.

Weak margins and the higher tax rate will likely remain a drag on the company’s third-quarter earnings. However, we think that a sharp YoY decline in the outstanding share count could drive RH’s earnings.

Management expects the company’s third-quarter adjusted gross margins to be lower compared to the previous year. RH projects the gross margins to be 40.1%–40.4% in the third quarter, which implies a decline by 30 basis points–60 basis points YoY. Management expects the deceleration in the sales growth rate and a planned increase in advertising to hurt its third-quarter margins.

Impressive Q2 performance

RH had an impressive second-quarter performance. The company’s sales and earnings beat analysts’ estimates. RH increased its fiscal earnings outlook. The company posted net revenues of $706.5 million—up 10.3% YoY. RH’s revenues beat the consensus estimate of $697.8 million.

The company’s adjusted gross margin increased by 40 basis points, while the adjusted operating margin expanded by 320 basis points. RH posted an adjusted EPS of $3.17, which increased 59% YoY and beat the consensus estimate of $3.08.

RH expects its adjusted EPS to be $10.53–$10.76 in fiscal 2019—up from its earlier guidance of $9.08–$9.52. Meanwhile, the fiscal revenues will likely be $2.680 billion–$2.694 billion—up from $2.658 billion–$2.674 billion.

Stock outlook

RH stock has risen about 72% YTD as of November 29. There has been a steady uptrend in the stock despite the company’s weak near-term guidance. We think that RH’s sales and margin headwinds are transitory. The headwinds will likely dissipate soon. We think that RH will see high growth in the coming quarters.

Recently, Warren Buffett’s Berkshire Hathaway disclosed a stake in RH stock, which should also boost investors’ confidence and support the uptrend. RH’s low valuation and high EPS growth could drive the stock more. So far, the stock has risen significantly this year. We think that a pullback could provide an opportunity to go long.

In comparison, Home Depot (HD) and Lowe’s (LOW) shares have risen 28.3% and 27.0%, respectively, YTD. Home Depot’s third-quarter sales disappointed investors. The company cut its net sales and comparable sales outlook, which isn’t encouraging.

Lowe’s third-quarter earnings beat analysts’ expectations. The company increased its fiscal EPS outlook. However, Lowe’s missed analysts’ sales expectations in the third quarter.