Investors are warming up HR (HR -3.09%) stock. Shares of the high-end home furnishings giant have jumped nearly 50% in the past three months despite sales falling and the industry remaining in price-cutting mode.
Is Wall Street right to sound the alarm signal for this stock, or should investors wait for more clarity on consumer spending habits before buying? Let’s take a closer look.
The latest results
Latest HR results show furniture salesman making the best of a bad situation. Sales fell to $869 million in the latest quarter from $1 billion a year earlier. Revenues were also down slightly in the past three full quarters.
This decline is not so serious if we consider the context. The home furnishings industry has contracted sharply in recent months and is facing huge gains from a year ago. Wayfair reported a 23% drop in the number of active customers in the last quarter, with order volumes falling by about the same amount.
HR sales are up 28% from the pre-pandemic third quarter three years ago, but the sales environment is currently weak.
Make your own path
RH decided not to lower prices to keep inventory moving during this slowdown in demand. This strategy carries great risks, including the potential for inventory depreciation or loss of market share.
The payoff is that RH still generates strong profits and positive cash flow. The adjusted operating margin reached more than 20% of sales, and the company remains much more profitable than its competitors in the sector like Wayfair and Target.
Management is also betting that the move will protect HR’s luxury status when the eventual rebound occurs. “[W]We believe there is some long-term risk of brand erosion…for those who choose the promotional route,” the company said in a letter to shareholders in early December.
Time will tell if RH is right to take this full price approach. Investors will want to monitor inventory levels for signs that the company is at risk of larger writedowns through the end of 2023.
But for now, the finances seem solid. RH generated positive cash flow last quarter and has more than $2 billion in cash, compared to less than $400 million in net debt.
Yes, the title seems richly valued at 2.6 times sales versus 0.8 for Target and 0.6 for Wayfair. But RH’s valuation had been more than 6 times sales for much of 2021, when sales and profits were skyrocketing.
Investors cannot expect a repeat of these exceptionally strong results, which were fueled by rising earnings and intense demand for home furnishings. But the stock deserves a premium for its market-leading profitability and strong cash position.
Cautious investors may want to wait for clear signs of stabilization in demand before buying RH. However, if you are not afraid of the short-term risk of a recession ahead of time, consider adding this title to your watchlist.
RH performed well during the peak of the pandemic and maintains strong momentum during the current growth hangover. These gains suggest it can deliver strong returns across a wide range of selling conditions, and it’s a valuable trait to have in your portfolio.
Demitri Kalogeropoulos has no position in the stocks mentioned. The Motley Fool fills positions and recommends Target. The Motley Fool recommends RH and Wayfair. The Motley Fool has a disclosure policy.