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Jefferies initiates RH at ‘underperform’, sees 15% downside

On Monday, Jefferies initiated coverage of luxury home furnishings retailer RH at ‘underperform,’ setting a $320 price target which implies a 15% downside from current levels. The Final Round panel break down the details.

Video Transcript

SEANA SMITH: Welcome back to “The Final Round.” Let’s get to our call of the day. Shares of Restoration Hardware are in the red with the stock off just around 3.5%. Jeffries initiating its coverage on the stock with an underperform rating, citing, quote, “inherent execution risk.” That, of course, is in their note.

Melody, first to you because this is a stock that we’ve talked about now for quite some time. And to be honest, the majority of the time, analysts have been coming out in favor of the stock, saying that they are in the right position at this point. They’re capitalizing on this stay-at-home trend, how consumers are shifting their spending behavior. It’s a stock that’s up just around 80% so far this year. But I think the big question here in this Jefferies note is just about how management is going to continue to execute their strategy going forward and some of the loopholes, potentially, in that strategy.

MELODY HAHM: Yeah, to your point about the bullish sentiment of this, I’m sure Jefferies may have seen Dan Roberts’s write up a couple of weeks ago specifically on the run-up, right? For Restoration Hardware and the, quote unquote, “road untraveled, less traveled” that this luxury home furnishings, furniture store has been able to really make waves during a financial crisis, right? Although, we have to note that 99% of sales for Restoration Hardware is domestic. So that’s one of the big kind of key flags that the Jeffries note is raising, saying how much more penetration with the upper echelon of the United States consumer can you really go from here?

I do want to point out, too, that this is a very contrarian note, as you alluded to, Seana. This is the only equivalent of a sell rating among all the analysts who do cover this stock. So we do have to think of it as perhaps the tides are turning. We should perhaps expect a slate of new notes, right? From other analysts going forward in the coming weeks, as we perhaps see this sort of change, this tidal wave shift back to, OK, we invested in that couch we had been lusting over. We had been saving for that one table that we really wanted during this work-from-home period. But how much more can you really kind of up your own home furnishings during this time? And this note, that’s sort of the bottom line here.

DAN ROBERTS: And guys, just to jump in on this, I mean, first of all, it’s a little bit refreshing for us here on “The Final Round” because how many notes that we discuss as our call of the day are big, bullish, brassy upgrades? And we have to quibble a little and take issue and say, oh, you know, they’re over-the-top bullish. Well, here’s a– you know, a bearish note on a company that, you know, has soared, as Melody said, during the pandemic, the stock, and really also kind of the glitz around Restoration Hardware.

Now, in some ways, the stock gains were already surprising because this is a company that, in the past and still, a lot of its cachet is about going to the store, going to the store in person. So even though they’ve had some positive, you know, online sales, it’s really one of those names that– it’s not a big, you know, online shopping name. It’s a company where you go and you’re in their store environment, and it’s experiential.

And in fact, maybe unlucky timing, but just before the pandemic, RH, which you know, it rebranded to RH four or five years ago. You’re not supposed to call it Restoration Hardware. RH, even more so, embraced physical retail, and it started opening what it calls galleries, both in the US and abroad. And in fact, just before the pandemic, the plan was to open a bunch more of these galleries in other countries, specifically in Europe and in England.

And by the way, on a September 9 earnings call– I have to read this quote– RH CEO Gary Friedman said, we are not building shitty little crappy retail stores. We are developing buildings. That was his quote. So you know, here’s a company that was really doubling down on physical space. And you know, more than a retail store, it’s a gallery. And the galleries serve you coffee and maybe tapas and bites. Oh, and maybe you’ll buy a couch.

So you know, in some ways, this note is totally fair because now, due to the pandemic, you know, the idea of opening new real estate is very, very much in question. Now, that said, on that September 9 call, Gary Friedman had noted that there’s very little overhead with these galleries, which is a little hard to believe. But that’s what he said, kind of in an effort to defend these plans.

But you know, in some ways, this is fair. Maybe it’s a little overly bearish, this note, because I think the company has very, very loyal shoppers, who just love RH. But I do think that with all the uncertainty in real estate, you know, it’s fair to throw a little cold water on a company that has big plans to open galleries.

MELODY HAHM: Dan, I do have to say, the galleries sound right up your alley. You love tapas. You love boujee coffee. You love some pretty aesthetics. So clearly, there is a market for this. I have to acknowledge that I have been to the RH rooftop in the Meatpacking District, as well as the first one in Chicago. So I can’t really criticize my own behavior, right? I do think there is this appetite.

And perhaps, as much as we are being cautious and conservative in our outlook of OK, how much will these sort of so-called experiential moments that millennials, that Gen-Z are really obsessed with– how much will they return post-pandemic? I do feel as though there is this appetite that has been pent up during this time, that people will kind of go crazy and perhaps splurge on places that perhaps they wouldn’t have gone to on an average weekend.

So that’s sort of my take on this Jefferies note. I do feel as though, as much as there is some hesitation and some logistical challenges with the real estate development and the speed at which you can open up these new properties, ultimately, I see them as, like, a Starbucks Reserve, right? Where it becomes a destination if you are in a city that happens to have one of these. So I do feel as though, ultimately, the tourist would be able to benefit, of course, looking down, you know, a 10-year period. This is not a short-term win here.

DAN ROBERTS: Now, do you want to sit and sip espresso and shop for couches with a mask on?

SEANA SMITH: It complicates things a little bit, I guess, right? But guys, I mean, the other thing to point out in this note was another trend that we’ve been talking about numerous times here over the last couple of months and just the fact that the pandemic has pulled forward acceleration and adoption here, especially when it comes to e-commerce, by many years. And that’s something that Jefferies also pointed out in this note. They were saying that some of their established omni peers and those in the digital luxury marketplace, that they, of course, also pose a risk here to RH– like you said, Dan, not Restoration Hardware– to its gains so far this year. Again, the stock up just around 80% since January 1.

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