Luxury furniture company RH(NYSE: RH) has been dealing with a difficult market for home furnishings the past few years, as the pandemic pulled forward a lot of demand for furniture when people were stuck in their homes. However, the company saw its shares soar recently following its second-quarter results, as RH (formerly known as Restoration Hardware) was able to generate revenue growth.
While investors sent the shares soaring, I think there are a number of warning signs that things are perhaps not as positive as they seem. Let's take a closer look at the company's results.
Revenue grows, but some metrics are troublesome
For the second quarter, revenue rose nearly 4% to $830 million, well ahead of analyst expectations of $824.5 million.
Gross margins fell 230 basis points to 45.2%, and adjusted operating margins plunged from 20.2% to 11.7%. This is the first warning sign: It looks as if the company greatly increased its marketing expenses to show a modest increase in revenue, crushing operating margins in the process. Adjusted earnings plunged 62% to $33.5 million.
Another area of concern is the big increase in inventory, which went from $737.7 million a year ago to $917.3 million, a 24% rise. Some could argue that the company is stocking up for the holidays, but remember that this is a year-over-year comparison, and the company only grew sales by less than 4%. It's generally not a good sign to see inventory and sales growth so far apart.
The company also saw a 35% jump in its accounts payable to $496 million from $366.6 million at the start of the year. And its deferred revenue and customer deposits only grew by $19.7 million, or 7%, to $302.5 million. This could be an indication that RH is extending the time it takes to pay its suppliers.
The company has made a big push into Europe with some large new store openings. But how well these stores are doing is uncertain. On its earnings call, the company said it was still learning from these openings and that it didn't open them in the order it wanted, which seems to indicate that they aren't doing great. Given that new store openings are often met with increased interest and traffic, this isn't a good sign.
Looking ahead, the company lowered its guidance for full-year revenue growth. It now expects revenue to rise 5% to 7%, down from a prior outlook of 8% to 10% growth. It forecast demand growth in a range of 8% to 10%, down from a previous outlook of 12% to 14%. (Demand is the dollar value of orders placed.)
For the third quarter, RH forecast revenue growth of 7% to 9%, with demand growth of 12% to 14%.
Image source: Getty Images.
Time to avoid the stock
CEO Gary Friedman has a reputation for making bold moves. For example, in 2017 he made a big bet on the company by taking on debt to buy back over half the company's stock. It was a gamble, but it paid off.
More recently, Friedman is betting on a push into Europe. But this isn't a typical retail push into Europe -- the company is opening huge, grandiose stores in markets where it has no presence and likely minimal brand recognition.
Entering the luxury furniture market in Europe is no easy task, but the company has gone all in, spending a massive amount of money and taking on big leases in the process.
For a valuation perspective, RH trades at a forward price-to-earnings ratio (P/E) of 24 based on next fiscal year's analyst estimates. For a company that has been struggling to grow revenue, that is a fairly pricey valuation.
RH PE ratio (forward 1y) data by YCharts.
Given its valuation and the warnings signs noted above, I would stay on the sidelines with RH stock. The company has benefited from big bets in the past, but that does not mean its European expansion will be a success.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool recommends RH. The Motley Fool has a disclosure policy.
