Over the past six months, RH’s shares (currently trading at $195.93) have posted a disappointing 6.9% loss, well below the S&P 500’s 11% gain. This might have investors contemplating their next move.
Is there a buying opportunity in RH, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Is RH Not Exciting?
Even though the stock has become cheaper, we don’t have much confidence in RH. Here are three reasons you should be careful with RH, plus one stock we’d rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
A company’s long-term sales performance is one signal of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Unfortunately, RH struggled to consistently increase demand as its $3.43 billion of sales for the trailing 12 months was close to its revenue three years ago. This wasn’t a great result and signals it’s a lower quality business.
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company’s incremental sales were profitable — for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for RH, its EPS declined by 39.2% annually over the last three years while its revenue was flat. This tells us the company struggled because its fixed cost base made it difficult to adjust to choppy demand.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
RH’s $3.97 billion of debt exceeds the $53.8 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $547 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. RH could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope RH can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
RH’s business quality ultimately falls short of our standards. After the recent drawdown, the stock trades at 29.7× forward P/E (or $195.93 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
Stocks We Would Buy Instead of RH
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