Why Did Buffett Buy RH? According to Berkshire Hathaway’s recent 13-F filings, it appears that Warren Buffett has increased his stake in the luxury American furniture retailer RH.
This isn’t particularly surprising. The company is cheap right now, and, amidst one of the most difficult inflationary environments for decades, doubling down on a high-end brand known for its opulent products is just the kind of idiosyncratic move that Buffett is well known for.
But is RH a good investment for regular investors? Or is it simply a speculative bet fit only for a portfolio with Berkshire’s margin of safety?
A Strong Brand With Affluent Clientele
The Oracle of Omaha is famous for buying companies with an impenetrable business moat. He plumbed for Costco because of its hard-to-replicate discount model, and likes Coca-Cola because of the loyalty its customers show towards the iconic drinks manufacturer.
But what exactly is a moat? Well, a moat is a competitive advantage that a firm has over its rivals. It’s what makes an enterprise unique and gives it an enduring edge.
Companies can build moats in many ways. They can offer low-cost products or services, have a special relationship with customers, or develop unique technologies or processes.
The key to sustaining this competitive edge is to have a barrier that keeps other companies from catching up. This could be an exclusive patent, highly skilled employees, or access to raw materials.
Over the long term, a business with a moat is usually expected to generate higher profits and enjoy more enduring gains.
In RH’s case, one of its moats is the superior brand recognition it garners within the wider market. For instance, when shoppers think about the company, they think of an upscale brand associated with luxury and high quality.
While some may see the price tag as a deterrent, many customers view it as a badge of honor. They know they are buying a product that’s built to last, and when it comes to furniture, RH is an exclusive brand that’s worth the extra investment.
Moreover, RH caters to a customer base with deeper pockets than the average shopper. Indeed, discretionary spending by well-off shoppers has been relatively resilient to inflationary pressures in recent years, with higher-income households able to maintain their spending on non-essential items. This is likely due to the fact that these shoppers have larger budgets to begin with, giving them more flexibility when prices rise.
RH Is Attractive From A Valuation Perspective
Despite the firm’s well-off customer base, RH hasn’t been able to insulate itself from the broader macro headwinds afflicting the home furnishing space of late. The company’s stock has fallen precipitously over the last twelve months, losing over half its market value since the turn of the year.
This is to be expected. Inflation impacts businesses in many ways, and, when prices rise, businesses must either absorb the increased costs or pass them on to consumers. Either way, profits are squeezed – and if inflation is already high, it can erode confidence and disrupt business planning.
However, every cloud has a silver lining, and a toned-down share price for existing and potential RH shareholders opens up a tempting buying opportunity.
Indeed, the company’s forward non-GAAP earnings ratio of 10.9 is significantly lower than many of its peers, while RH’s gross margin increased 350 basis points year-on-year from 49.3% to 52.8% in the second quarter of 2022.
Additionally, while the business recorded a modest spike in quarterly sales during the latest period, its revenues have actually risen 40% over the last two years, going from $709 million in 2021 to $992 million today.
That said, adjusted net income fell 14% to $217 million, with the firm’s operating margin also dropping 190 basis points to 24.7%. However, that 24.7% is higher than the 23.0% to 23.5% predicted in its fiscal 2022 outlook and therefore shouldn’t be viewed as a negative development.
What Lies Ahead For RH?
Recognizing that there’s been widespread discounting throughout the sector, RH has decided to risk losing short-term market share in order to protect its brand and product elevation in the future.
In fact, the firm is building on its famous galleries concept to deliver an “integrated ecosystem of immersive experiences,“ inspiring its customers to engage with the venture in a special and unique way.
To accomplish this, the company is expanding its RH Guesthouse offering, in the process creating an opening in the $200 billion North American hotel industry. Furthermore, the company is beginning to curate other bespoke activities, such as its luxury yacht and private jet adventures.
While RH doesn’t offer a dividend yet, the business is determined to reward investors in other ways. To this end, the firm repurchased one million shares of its common stock at an average price of $255 per share in the second quarter, and spent an additional $88 million in buying up some of its outstanding convertible notes.
Wrap-Up: Why Did Warren Buffett Buy RH?
While its near-term growth prospects are fairly muted, RH’s brand has plenty of ways in which to evolve. For instance, the company is planning to open its first gallery in England in the Spring of 2023, and will be adding a store in Palo Alto to its other 120 American outlets pretty soon.
Most importantly, RH is in an excellent place to see out this difficult financial spell, and, when the economy really starts to heal, the firm should rebound with increased vigor.
When we ran the numbers, the cash flows confirm the investment thesis. We arrived at a fair value for RH of $417 per share, suggesting upside of as much as 56% by forecasting cash flows and discounting them back to present day.
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