Chit Chat Stocks - RH (RH) | Not So Deep Dive

Episode Date: April 26, 2022

Formerly known as Restoration Hardware, RH is a retailer in the home furnishings industry. The company markets various products across multiple platforms including retail stores, catalogs, and online. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of RH. Enjoy the show! This episode is sponsored by Commonstock, a social network for smart money investors. Check-out the platform here: https://commonstock.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Contact us: [e-mail] Timestamps Company Background | (3:00) Industry | (8:33) Management & Ownership | (9:51) Valuation | (13:39) Earnings | (15:19) Balance Sheet | (17:24) Our Analysis | (18:24) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. This is the show where we cover an individual stock for probably 45 minutes and get you the basics of a company,

the basic financials, history, what they're doing, what their plans are. And today we're talking RH, formerly restoration hardware but now called just rh i think just that not even rh group or anything it's very short it's clean like the social it reminds me of the social network uh line but we're going to get to that but we have to talk about our sponsor first common stock common stock is a social network for smart money investors we've talked about them a lot and brad freeman is joining us today you just i don't know what the it's called signed a deal signed a deal yeah I guess I did a deal with a common stock. Do you want to talk about it?

Maybe not another deal, but like why you like common stock and why you think it's a, it's a great platform. Sure. I think they've kind of borrowed the good things from Twitter and, and maybe kind of sidestep some of the, the not so good things. And I think the last few months we we've all kind of seen how the not so

good things can kind of manifest themselves. And it's not even the last few months, But I mean, Twitter can get pretty noisy and toxic and deflating and common stock is just a more focused environment where I found it to be more uplifting and more kind of in this together and more transparent with portfolio sharing than Twitter. So it's something that I've quickly grown to use a lot and then am now partnering with them and sponsoring them with the newsletter and doing a lot of cool things with them. So yeah, I agree with you guys that cool company for sure. So partnering is that that entails you just kind of promoting them on the show. Is there any on your newsletter? It's called Stock Market Nerd, if anyone's interested.

It's true. Yeah. Newsletter sponsorships. I'm going to be doing some things that I can't really get into specifics on in the site or on the website itself, but excited to share and show as I can talk about it more. That's a good advertisement for common stock because it shows that they have good taste. That is exactly right. And if you want to go to them, go to commonstock.com, join other smart individual investors who want to share their portfolio ideas. All right, Ryan, introduce RH, one of the most fascinating companies. I'll tease it again here that I think we've covered on the show. Yeah, I don't know if the basics of the business are like super enthralling, but the direction they're headed and sort of the management and just the company in general is kind of interesting.

So the first line in RH's, I feel weird calling them RH, in RH's 10K says, RH is a curator of design, taste, and style in a luxury lifestyle market. Basically, it's a high-end retailer of home furnishings, but it's added some unique characteristics as well. And so they primarily sell these, they sell through these really grand, I would say, locations, which they call their galleries. And so these are, they basically function as a showroom and they're stunning looking like you, you notice it no matter where it is. It's, it looks like a European villa almost like it's like these castles in the middle of shopping centers. And then they in inside, they sell like, um, anything from furniture to lighting, home decor, outdoor and gardening items. And then there's like teen and kids furniture as well.

Um, and these are really expensive things too. So it's like the cheapest couch 10 is around $4,000. And if you get like a second sectional, it can go upwards of 10 K. So really expensive, really trying to curate or, uh, tailor to the upper class. um and it as far as sort of logistics go it sources products by working closely with third party vendors and manufacturers about three quarters of their purchases came from 29 vendors with the largest one accounting for 11 so uh pretty good i guess supplier diversification there and then they manage their own distribution and distribution and delivery so they have home

delivery services for their customers basically they're trying to make this the most comprehensive luxurious shopping experience a customer can find um and so the business it's pretty easy to understand and one thing though you can't buy at the store you have to it's like it is a gallery right you have to like you can't take it home the day of i think it's like purchase and then you know they'll deliver it to you i think it's almost like peloton in that sense where like exactly you're picking your item um but you're not like taking it home from there uh but i don't I think that pretty much covers the basics of the business. They are doing some tangential... We'll get into that. The RH3, you guys going to try to join us on the Gulfstream?

It's our future growth opportunity, so we're going to talk about it in a little bit, but they're adding some new characteristics to the business that are kind of interesting. And then as far as history goes, pretty fascinating here. So RH or Restoration Hardware, as it was uh known initially was founded by stephen gordon in eureka california in 1979 it was a similar concept to what it is today only it was just hardware so not like furniture and then they didn't have quite the luxury appeal but basically gordon who had a bunch of experience working in merchandising tried he he thought there was a market for high quality uh but affordable hardware. And so he started what turned out to be Restoration Hardware. That business expanded

gradually and eventually they IPO-ed about 20 years later in 1998. Fast forward three years and Restoration Hardware hired Gary Friedman as the new CEO, still current CEO. Brad's going to talk about him here in a little bit. But Friedman, from what I can tell, he's worked in retail all his life. He was a stock boy at Gap in his early days. And then he was rejected or passed over for CEO role at Williams-Sonoma, so he joined RH instead. For the subsequent years after 2001 to 2008, they continued to grow, but then the great financial crisis crippled them to some extent, and they ended up getting bought out, I believe, by a private equity firm. They went private, delisted, and in that time, they decided to make this brand change to go

more upmarket and they rebranded as RH. In 2012, they re-IPO'd. Keep in mind, Gary Friedman is still the CEO by this point. The stock was sort of a battleground stock. Everyone thought they were going to either get killed by Amazon or this luxury strategy wasn't going to work. There's this famous quote from Gary Friedman in 2017 where he says, 52% of our shares were short for God's sakes. Okay. Honestly, and the shorts and those in you in the room, listen, I don't care. Everybody can gamble the way they want to gamble. Honestly, again, I care about large long-term investors. So since that point, the stock's 10 X and that was like five years ago. So it's been a wonderful investment since he also kind of announced a

levered buyback at that point. With convertible notes, kind of interesting. We're seeing some of the dilution come back today, but it took down like 50% of the shares outstanding in a year, which was, I don't want to say the word ballsy, but ambitious. He's not afraid to make, the team there, especially, it's not just him, the team there is not afraid to make big, bold moves. Yeah, the luxury transition worked. I guess we can confidently say that now. Today, they are a big company, 81 retail locations, right?

You're going to get into the valuation or industry here as well, but they're humming along now. Yep. And I'll hit industry and competition here. Yeah, they are doing quite well. The transition has worked, I guess, over the past five years. I will tease kind of their future growth plans here, but we'll get into that in the second half of the show. I mean, there's really two markets. Their current market is fairly simple. It's upscale. I didn't spell it right here, but it's furniture market. than their future industries that they're trying to target is hospitality, restaurants, and travel. Management believes there's about $20 to $25 billion in demand worldwide for their niche in the furniture market, which is basically home furnishings. And that is out of the total home furnishing market of about $170 billion. Their long-term market gets a bit into the kind of TAM sanity stuff at about $7 trillion to $10 trillion TAM estimate. That's for management.

I would really just ignore that and focus on how well they're executing with these new initiatives that they're going through. And then competitors, there are a ton out there. It's a pretty mixed market. There's a lot of different ways people go about it. There's some that serve the business side. There's some that are cheaper. As people probably know, most couches aren't $4,000. But competitors are someone like Pottery Barn, Ethan Allen, The Citizenry, Herman Miller. Wayfair is an interesting competitor. That's more of an online one. I mean, Amazon's a competitor. There are really tons out there. Pretty simple industry. I think people can understand. Brad, do you want to hit management and ownership? Yeah. So Gary Friedman is the

current CEO and chairman of the board as well. On the website, he's credited with kind of being the founder of the RH brand as we know it. So Ryan talks about that brand refresh and then becoming RH. And Gary Friedman is really the guy responsible or credited with that transformation. He climbed the board for a long time with this company. He'd been there on the board since 2001. So he definitely paid his dues before becoming CEO. He was the former president and COO of Williams-Sonoma, as well as president of Pottery Barn.

Awesome resume. He does have the lowest Glassdoor score I've ever seen with a lot of reviews. I think there were like 1,300 reviews. And he's got a 46% approval rating. I mean, that's not a red flag, but it's just, it's notably bad. He's controversial, right?

controversial character for sure yeah he yeah um that was that was a that was surprising to me or maybe it shouldn't have been but but it was but um the president is ari chaya sorry if i mispronounced your name uh she also climbed up the ladder for a long time former banana republic creative director uh and then just a really i mean it's interesting to juxtapose the terrible glassware rating with the executive tenures that have been very long um across the board so clearly his his leadership team likes him, but maybe his employee base doesn't as much ownership. And this is maybe another source of the controversy. Gary owns 28% of the company. His total compensation of $178 million from 2021 was thanks to a massive options package. His salary is only a million.

But I mean, he got that 28% through very, very generous options packages and performance incentives and then he was just given another several hundred thousand share bonus for 178 million this year um yeah so so he's very well paid um so i will leave it there uh blackrock owns 8.4 berkshire hathaway love to see that owns 8.2 percent tiro price on six goldman's tax owns 4.6 all directors and officers own about a third of the company and gary's pretty much all of that ownership. Needless to say, Berkshire does not care about Glassdoor. Buffett's not a Glassdoor ratings kind of guy. Yeah. It probably wasn't him that bought it. It was one of the other two. I guess we don't know for sure, but they took a large stake and they've held it for a long time.

So hopefully they kind of see it. As we can get into later, there are some similarities to maybe Apple and some of the other brands that people like. One thing I want to talk about with management, what do you guys think of Friedman basically laying out a pretty ambitious plan right on front of every single letter they do and write on the website like we're gonna be this we're gonna climb the mountain we're gonna whatever it sounds like almost like a coach or something what do you guys think brad what were your thoughts on that it's like as a potential investor he's he's got a flair for for the dramatic i i think is is a decent way to put it i mean if you've read if you've read any part of his prepared remarks from last earnings call um it was kind of like bill

ackman like prepare for shock you know like he was he was a doomsdayer and and then kind of comparing that with what you're talking about he he's just he's got a lot of personality and i think um as evidenced by some of the things we've talked about you either love him or you hate him um and and uh yeah probably just i'll leave it there yeah ryan would you same thing maybe yeah he's definitely intense for uh being the ceo of a furniture store um and i know it's more than that now. And maybe that's what they need, I guess, to build the luxury brand. But some of his quotes are a little outrageous. I do like how he treated the animals when they asked the same question over and over. He goes, what do you think? No, no one says that. You're spoiling my

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All right, valuation, market cap, $8.3 billion, tickers RH. Enterprise value is right around the same as the market cap if you exclude leases. And calculating that with that, do what you want there. They have some finance leases and operating leases that I'm sure Brad will talk more about stuff like that in the balance sheet. They just took out the term loan again, but I'll talk about the balance sheet price to sales 2.2 price to operating income of nine and price to free cashflow of 17. Now the discrepancy between free cashflow and operating income and all these metrics

are just taking the market cap divided by trailing whatever metric, whatever financial metric. So price to free cashflow is different than price to operating income because they are in a heavy investment period. They are doing quite a bit of CapEx relative to their size, I think about 200 million. And they have an inventory headwind at the end of last year. They have been very, very strong over the last five to six years of improving their working capital and getting better just cashflow generation because of the inventory turnover. But last year, not as much as probably just short-term things with the pandemic.

And then lastly, there are a lot of tugs and pulls, but the dilution and the options that Brad is talking about with ownership, the convertible notes, there's some debt and there it's really too much to talk about on the show. You can run exact numbers in detail, but from the 10 K they had about 7.7 million options outstanding versus 24.5 million current shares outstanding. I think the majority of those are going to hit except for possibly the ones that were just granted. So the market cap, the true market cap is slightly higher than what we're seeing here. And if you look recently, they just converted some of the convertible notes and the share count bumped up by quite a bit.

All right, Ryan, do you want to hit earnings? Yeah, in 2021, they had $3.8 billion in revenue. That was up 32% versus 2020. It was up, I think, 42% versus 2019. And then on that revenue, I was going to say restoration hardware, RH had an adjusted operating margin of 25.2%. That's also up a decent amount year over year. but it's more than 1,000 basis points from 2019. So they had 14.3% operating margin in 2019. Now

they have 25.2%. So they've been able to become way more profitable in the recent years. And then as Brett mentioned, their free cash flow was, I guess, down compared to what it would normally be. They had $477 million in free cash flow. That's about 13% free cash flow margin, but that also includes a $191 million increase in inventory, which hurts cash flow, I guess, for anyone who's unfamiliar. A lot of that was attributable to the supply chain problems. He got into this on the conference call in basically a clip that almost went viral when was asked about whether or not the supply chain problems affected their new product launches he

said what do you think of course it's impacting launches and then he goes on he says i mean the supply chain i think many of us thought it would have been uh would have been caught up by now i mean we'll be lucky to be caught up by the end of the year and because it's just hitting everybody from all angles all the raw materials all the transportation issues not just the transportation getting it to us our vendors having to get all their components from all over the world shipped to them. So you just have this compounding supply chain kind of puzzle happening. He really did sound like a bit of a doomsdayer on the conference call. You wouldn't have expected it, I guess, from just reading the results from his report. But I guess 2021 was a record year for him,

but you would not have thought it just listening to his commentary. I agree. All right, Brad, do you want to finish up all the financials here with balance sheet? Yep. So the company has $2.2 billion in cash and equivalents on hand. So Brett kind of talked about a term loan that they recently raised, which was for $1.9 billion. They've got another $294 million in outstanding convertible notes. As again, we kind of alluded to, they really aggressively use these convertible notes. They paid off most of them, but still $300 million outstanding. So obviously that's not nothing. A lot of options outstanding, as Brett talked about, only 2% delusion from a share count perspective from 2020 to 2021. But it sounds like that could be

a little lumpy just considering when these options, gifts, and packages vest. And it's operating cashflow positive despite the really heavy investment phase. So you can't call the balance sheet pristine, but it's not a red flag. It's adequate. Yeah. They're not afraid to use financial engineering. And it's been to their benefit. So yeah, so far it has been quite to their benefit just because of the way they were able to take down the share count um cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you

all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply let's move into anecdotal evidence brad anything have you been to one i i'll put my hands up i have not uh i'm not a luxury aficionado brad any thoughts yeah i got nothing i i mean i've probably sat or used a table that restoration Hardaway was responsible for selling me, but I don't know. Yeah. I've never, I don't think I've ever been in one maybe when I was like a kid or something, but that was kind of a different business at that point. There is one in Seattle that I drive by a lot and it looks crazy, like crazy out of place, right? Yeah. It's, it's basically this European castle in the middle

of a college shopping center. And it's just, it's wildly out of place, but it, it looks nice. you're trying to get the uh i don't know exactly how many a hundred thousand people in seattle area that are very wealthy there's plenty of market opportunity here yeah but it i just it's funny where it's located but the building looks quite extravagant yeah they kind of those weird the location strategy has been unique but it's worked out quite well for them um i mean mine i don't know i have no i don't know it seems fine like i don't have a grasp on it i've never really been And I'm a recurring customer. I, yeah, I mean, I think their target audience is the people that are worth more than $10

million a year have incomes of like $500,000 a year. So none of us are in that yet, maybe sometime in the long term. But I mean, I think it sounds like a good, fine place to shop if, you know, if you had that kind of money, I don't know. All right, let's move into future growth opportunities. Brad, what do you think? Yeah. You guys got the, the two probably most feasible ones. So I'm going to, I'm going to get a little creative and, and, and say things that will probably never come to fruition, but you never know with them. You never know. Exactly. Because he's so ambitious, I feel comfortable being this kind of outlandish. But I thought about maybe like auto OEM partnerships and maybe if they're that high scale furniture, couch company or whatever, just kind of for the loosest of the world and the companies trying to go after those higher, higher affluency customers, maybe a partnership with them that they do the interior or something like that.

also Peloton. I mean, they're, they're this they're this upscale indoor furniture company and in Peloton kind of seems like it fits that, that vision, that culture a little bit, if they wanted to expand into in-home gyms, which, which they've shown no indication of wanting to do and Peloton's pretty cheap right now. So that now would be a decent time. I don't think that new CEO's in a position where he wants to sell. He's got a lot of options and promises coming his his way but um but yeah i mean go buy peloton restoration hardware i think and it's like an eight billion dollar market cap in peloton's four so that would be a massive undertaking but but still go ahead and do it and entertain me yeah i've seen peloton's market cap here i think

four billion dollars would be another 50 drawdown so if that happens it could be feasible right now their market caps i think are a little too close unless they want to merge but it does that does uh it does fit in pretty well with their peloton rh yeah it sounds i could see the merger well Well, it's overlapping the target audience, the audiences. All right, Ryan, what do you have? So this one is basically the one they've talked a lot about, and that is moving to hospitality. As I mentioned earlier, RH is trying to make their customer experience more holistic. So this includes live fire restaurants, caviar bars, wine bars, and even guest houses.

So far, they've integrated RH hospitality into 13 of their locations, and they plan to expand it into more as well as making it uh basically a staple of all their new galleries um they say that this should not only increase spend through obviously like the hospitality features but uh rh believes that the addition of hospitality will drive incremental sales of home furnishings as well i like the thesis here it seems pretty simple drunk people spend more oh let me catch you there they don't serve alcohol wine bar no no the they don't serve alcohol the ones in the at least from what i read someone's uh there was a presentation from bill brewster that said they decided not to do alcohol in the q4 letter they said they had

champagne and i know but i think i think it at the i don't know maybe they changed their strategy in the last two years but they said they didn't like specifically didn't want it it does feel a little exploitative uh to give them yeah he said he wanted it to be his because women are their core items. He said he wanted to be in a place where women feel as comfortable as possible. Let me confirm while you continue to talk. Okay. Well, that's sort of the basics of it. I don't know about the guest houses. That seems strange to me, but maybe I just don't understand the habits of the ultra wealthy. But I imagine it's not just sleeping on one of the couches in the gallery. It's probably a little more of an extravagant experience. Did you find anything?

uh the 10k said they have wine bars yeah but that might be different yeah that could be like separate than the core one that's the core restaurant in the place i'm seeing conflicting things here but there was a quote from two years ago maybe they changed their strategy all right what uh what's your future growth opportunity yes this is the the one that they're doing the most this will be the one that contributes to revenue in the in the near term and that is european expansion so this is happening in 2022 in the next few years beyond that In England, France, Germany, Spain, galleries opening up in all those major cities, think Paris, London, or Berlin, Barcelona, I think Madrid. Friedman thinks there is less competition in luxury furniture in Europe than in the United States.

I wouldn't really know that, but he probably has a better grasp than me. However, it is still kind of a big risk since the luxury product culture or just consumer culture is a little bit different or very different in Europe compared to North America. will RH be embraced? I mean, that's a big question. I don't think we really have, I don't think we can answer that, but do you guys have any speculation on that? I kind of feel like it will work.

I think it'll work. What do you think, Brad? I think their fancy American brand probably will resonate pretty well in Europe for the target market that they're going after, I think. It feels kind of like European luxury already. kind of but it's fake luxury though or it's just kind of fake luxury though i mean those couches look pretty nice i know it's but in the way like no in the way that the true european

luxury like what a louis vuitton and uh ferrari in comparison to that the top dogs it's fake luxury but obviously there's different tiers it's not that level yeah but that's europeans the top top level quote unquote so you know that's i think they probably if they're if they're going full-blown launch into europe i imagine they have some metrics that are pointing them to do that right the people worth 100 million dollars might scoff at them but everyone else that has any sort of spending power will be fine all right highlights and lowlights brad uh what would you like and dislike about this business yeah mine is actually more macro um for in terms of highlights and i I know Gary Friedman was very alarmist on the call, but if you look at kind of forward-looking indicators for freight and for inventory pressures and for commodity pricing, they're beginning to kind of fade.

And today is not a good example of that. But over the last few weeks, we've begun to see peaks in those prices in terms of lumber and all these input costs that restoration hardware is really focusing on. So highlight for me is I think we're weeks removed from kind of level setting expectations and lowering the bar for outperformance a lot, a significant amount, which I think is going to make outperformance or it will make outperformance a lot easier going forward. So a little bit of a weird highlight, but I wanted to mention that. And then so, yeah, and I think a bottoming of margins or margin pressure at least could kind of come to fruition. The low light is, and Warren Buffett told me to say this, is the Glassdoor rating really stood out to me. I've never seen, I really have never seen that before. Below 60%, I don't think I've ever seen. And it's not like 98% is, yep, I'm going to invest in your company

and a great sign. It's just one of those things to kind of check off the list and not worry about as much. But with him, with Gary Friedman, you do have to worry about that. So that is the low light um you you the attention or the the ceo fetches a lot of attention um and that's not super appealing to me honestly i yeah he has been a little radical i it may be the word um he's obviously kind of curt with some of the analysts and very i guess frank with them in in some cases well that's funny they're all yeah it's all right to bully the analysts it's not right to bully the employees um but the the other thing is they there was um he was removed as ceo for like one year at one point for a relationship with a subordinate consensual but still yeah it is

just a weird look for a ceo to do that um i do like his capital allocation though he's run the company really well obviously so far um i also think the luxury market if they're able to go true luxury, like make it a whole luxury experience that would do better in a recession. And I think they can be successful with these new initiatives. I think of the hospitality. I don't know about the guest houses, but I think the rest will work. What about the planes and the yachts? I don't know. That seems, I mean, those are only small things, but it's interesting. I mean, I don't know. The guest house in New York is, it's different because it's not even like an airbnb thing it's not like a hotel it's like nine rooms super private probably pretty expensive

like almost like something to get out of the city almost like what do they call those houses that exclusive house type things i don't know it can drive the importance of the rh membership to just be more valuable yeah i think they can go i think they do like i know they talk about climbing mountain of luxury i think they can climb that and they've been able to do it well so far so i guess that that would be my highlight low light for me though they are in a really tough spot obviously right now with the supply chain um 69 of their products come from asia i saw a chart this morning that uh showed there are almost 800 ships waiting to load or discharge in shanghai right now it's at an all-time high and by a long shot so i it doesn't it's hard to know what cash flow is

going to look like in the short term and as it will be better because there's no inventory okay over the next two years i have no idea what it'll look like but the i think gary painted the picture probably pretty well he said i'll be shocked if it'll be if these problems will be gone in a year um i mean we were talking about this during covid we were like these supply chain problems will be gone in a year it's been almost like what two years since uh yeah since the first kind of supply chain problems year and a half yeah and i don't think we're a whole lot closer if anything we're in a worse spot uh well brad was saying there's some decent data but yeah i mean those are and that's that's not i mean asia is the exception in terms

of in terms of kind of freight build-up it's better in in north america just because of those those trucking um restrictions and vaccination stuff kind of went away um but yeah asia if they're and i didn't know they're sourcing three quarters of their product from asia so that that is that is a concern for sure yeah two things on that one the shanghai lockdown yeah definitely threw a giant wrench into that and two since 69 of the products are sourced from asia that kind of hints to me the the fake luxury thing i don't say that products just from their asia are bad but you know that like there's obviously products there but yes i think there's obviously some efforts to maybe cut costs? The people that knew, the analysts that I read that knew the company

well and that shopped at the stores said it's still kind of like fake luxury, but they're able to charge a high price. So, you know, all to them. That's not a negative. I want to know the difference, but neither would I, but apparently their customers don't either. All right. What are your highlights and lowlights? I mean, highlights, it's definitely an upscale brand now with pricing power, looking at where their margins have been strong unit economics, great real estate strategy with good returns on invested capital, which is very important for a company like this that is taking those big gallery investments that cost maybe tens of millions of dollars. And I think there's a lot of optionality with these new initiatives. They're

high risk, but we'll see. Lowlights, I think there's two main things that I don't like. One is that they're probably still tied to the business cycle. They're not Ferrari or Louis Vuitton yet. And they are more consumer discretionary. So if anyone doesn't really I know a lot of people know what that means, but just to give an example, consumer staples is like grocery store stuff. You're going to have to eat all the time. So you're going to pay for that, even though inflation is going out of control. And if you have less money to spend or you're less willingness, the wealth effect is kind of disappearing. Maybe if the stock market is going down, you may not be wanting to buy a thousand dollar chair from RH.

and that concerns me as a low light just because their margins seem to peak with where the business cycle peaked let's see what happens over the next few years if the economy in the united states slows down yeah it is hard to call them recession resilient when it sounds like the financial crisis almost broke them but that also is it sounds like the moment that spurred them to go up market Hopefully, they're less cyclical now, but I still don't think they're not cyclical at all, if that makes sense. Second one, growth initiatives are on the border of ambitious and reckless. I don't know. They feel a bit reckless. Yeah, I didn't read about the Jets.

They got the Jet, the RH1 and the RH2. That's what they're calling it. Are they like Jets? They're goal streams that you can, if you're an RH member, you can buy. And then there's a yacht that RH members can take in like the Caribbean. Okay. That feels a little risky. Yeah, it does feel risky. Luckily there's only two right now, but I mean, it also could make an RH membership feel pretty worthwhile. Who knows? Yeah.

All right. Bull case, Brad, what's your bull case here? Yeah. It's hard to say or get more creative aside from new products work and new markets work. But, but, but aside from that, I think the bull case is if, If we do have this economic downturn like everyone and their mother is predicting we do in 2022 or 2023, and both of you guys hinted at this, but their catering to more affluent clients means that their clientele is inherently less price conscious, which means that they could probably enjoy some demand outperformance and maybe a little bit of pricing power to kind of offset the supply chain issues. And I think, um, that is the bull case that they are, that they aren't Louis Vuitton or, or, uh, Ferrari, but, um, they're also not a tattooed chef. Not, not to, not to, they're not gap. Yes.

They're not gap. Exactly. Yeah. They're, they're, they're, they are, uh, building brand equity quickly. And I think that brand equity could manifest itself in there enduring these tough times a little better than some others can. Yeah. I, there's a stats out there.

If you want to read a great write-up, mostly borrowed ideas, he does great analyst reports or maybe someone that they're very highly detailed. So if you're kind of an individual who doesn't read in SEC filings, if you're someone that reads SEC filings, MBI is perfect for you. But he had some stats about the number of people worth over $10 million in the US.

And I believe it's 1.5 million people. Right now they only have 450,000 members. And I say the threshold of $10 million, say worth $10 million, because you're going to be fair unless you're levered up as like, say a real estate investor or something, and you blow, you blow up in the recession, you're going to be pretty resilient in your

spending habits. And those people may be able to carry them, the RH brand. And they mentioned in their SEC filings that 97% of the revenue, which again, 97% of the revenue comes for the 450,000 RH members. So it doesn't matter if, I don't know, it doesn't like, it's really those, the wealthy, the 1% of the United States. This is a great wealth inequality play. I mean, if you're long wealth inequality, this is the place to do it. Now, what if that cycle is breaking, though? That could also be a headwind for them. Because wealth inequality over the last two decades could have been beneficial to our age.

I think it was. If that reverses, I think that's headwind. Yeah, maybe. But I don't have any good guess as to whether that's going to grow or shrink. But the bull case for me is if they can hit high single-digit revenue growth, maybe even double-digit revenue growth, and get back to maybe high teens free cash flow margins, or at least get those free cash flow margins a little closer to their operating margins, this is going to be a great investment. I think this could be 20% plus returns because you're literally paying probably low teens cash flow multiple right now, maybe mid-teens. But I think there is a lot to like here if things go right. Yeah, I agree. Yeah, I'm kind of in a similar boat. Given the decently cheap valuation

on the trailing numbers, I think you need to believe North American business is fairly immune to the economic cycle and has room to grow. I still think there's $5 to $6 billion of revenue in the United States. And what did Ryan, what did you have Ryan? It's a little less than $4 billion in revenue, I believe. And then the European expansion, I don't think it needs to be a success, like a huge success, but if the European expansion is a success, excuse me, they can drive top line growth at about 10% plus a year. And if the bottom line is either stable or margins tick up to 30%, like I think they can get, then bottom line will go quicker. I don't think you need to do any fancy modeling as long as the dilution is fine. And maybe they

start buying back shares again um returns will be good all right bear case brad what are your thoughts yeah um i guess that it's closer to tattoo chef than it is louis vuitton and ferrari in that um this kind of facade that they've built in terms of catering to affluent clients is is not um is not something that they can use to offset pricing pressures and not something that they can use to do things like succeed in Europe, where there is a large cohort of probably interested borrowers that fit their demographic. So it's a boring bull case. It's a boring bear case. It's just they don't execute. It's their bear case. I mean, when you have this consumer discretionary brand, it really is about management quality and capital allocation and execution. And so that's

what has to happen and if it doesn't then it won't work yeah the it's it's hard because it's like if if these things work and they're able to increase their uh revenue on a per gallery basis and then expand their galleries this is obviously going to be a good investment the my concern is that and i think this is obviously the market's concern too that the short-term headwinds could throw a wrench in like growth initiatives especially if capital is really tied up and restricted and all these supply chain problems could be good they took out that term loan recently that could be helpful yeah i guess i don't know the concern the concern for me is the short term and then maybe reckless capital allocation yeah or risky capital allocation

yeah it's interesting the big like question and for like a luxury product is kind of like When the price Of what it costs Is the product Like whatever Louis Vuitton Or Ferrari Or

I think RH has that Tiffany's I don't know That's the question I am not sure Does RH have that Is the price The product

They basically Moved up market And gained traction Doing it Yeah So far I think I mean

Everyone compares Stuff to Apple All the time it feels closer to that where it's like half luxury where you know you know like i wonder apple's a good comp i'm saying apple's a fantastic way to go fantastic comp um all of my bear case same thing new products burn a lot of money and cyclicality is more of an issue than we think i think that is really the bear cases that we all had let's move into the last question more or less interested brad final thoughts on rh yeah i think more uh more interested um it's not

it's not that 15 plus compounder that i really like but it does seem like it could grow not it could grow close to 10 or 8 9 10 in that range for the next few years and at a i was just looking at the multiples like i think it was like 10 or 11 times ebita and something like that there's there's a lot to like if they can continue to figure their stuff out and we do have evidence of them making a pretty dramatic pivot and figuring it out when people thought that they wouldn't um so uh probably we'll just keep an eye on this um a little i i should say a little bit more interested not not super super more interested but um i think more interested is a good classification all right right i think i'm gonna go less interested oh surprise i thought

you're gonna be more no it doesn't feel very predictable uh yeah i don't know what these initiative how these initiatives will play out i imagine they are seeing good traction with them since they already have them in 13 galleries and they're really plowing money into them well restaurants is different they've proven restaurants in the galleries but the other stuff is way unproven yeah and i um yeah just hard to predict less interested i think i'm more interested but i mean if this was something that was asset light didn't really have any um uh impact from like the physical world cost and also if it didn't combine that with consumer discretionary i mean at this price given the historical track record execution it would seem

awesome but those are just the big hangouts for me personally i just like stuff that doesn't have energy price uh lumber whatever all those prices as inputs it just lowers the bar a little bit for me compared to something else at the same price yeah um but i'm still very i like i'm still more interested it's going it's already gone on the watch list i mean it's something to watch it's also a fascinating story also fun to see all their initiatives that's what yeah this is fun to look at but it feels like you could get this kind of upside elsewhere with less risk associated with it like uh maybe we can't talk well yeah we don't want to talk uh we don't want to uh no we're allowed to but uh digital businesses generally yes exactly you've had

that's a good example yeah just some of those feel more predictable right now with potentially the same sort of upside yeah and predictable of operating expenditures uh expenses as well as input costs and stuff like that as well as growth growth yeah overall growth yeah exactly all right that's gonna do it stock for next week is ryan's turn what do you got for us okay so we got a recommendation uh oh in the review in the no uh i did not check the reviews do we have any in there We had one, it's one we might want to cover on the live stream because it's like a micro cat type deal. Oh, okay.

Maybe avoid that. But someone DM'd me and they want to do Brookfield Asset Management. Have you heard of that? I've heard of them, but haven't looked at them in any details. Brad, have you heard of them before? Nope. All right. Cool.

Okay. That's our homework assignment. All right. We'll see you in two weeks then. Anything else, Ryan? Nope. All right. That's going to do it for this episode.

Thank you all for listening. Remember to give us a review, easy review. It takes five seconds on Apple Podcasts or Spotify. Check out Brad's newsletter, Stock Market Nerd. Well, I believe we always have a link in the show notes if you want to read his write-ups. Always for free, right? Yes, sir. All right.

And let's give the disclosure. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time. Thank you.