RH: Building A Luxury Empire

Jason Kempin

Restoration Hardware, now known as RH (NYSE:RH), was transformed into a luxury brand juggernaut under the leadership of CEO Gary Friedman.

RH was founded in 1979 by Stephen Gordon in Eureka, California. The company was established while Gordon was restoring a Victorian home and found it challenging to source affordable, high-quality hardware and fixtures. This experience led him to start a business that catered to similar needs for others engaged in home restoration and renovation.

Stephen Gordon – Founder RH (Stephen Gordon – Founder RH)

Friedman, who joined RH nearly 20 years ago after a stint at Williams-Sonoma (WSM), has been instrumental in the brand's evolution.

Friedman held several leadership roles at Williams-Sonoma before joining Restoration Hardware (now RH). He joined Williams-Sonoma in 1988 and over his tenure there, he served in various executive positions, including as President and Chief Operating Officer. His roles involved significant responsibilities in managing and growing the company's various brands and operations.

During his tenure at WSM, WSM's stock rose 1,600%.

WSM Stock Performance under Gary Friedman (WSM Stock Performance under Gary Friedman)

Friedman thought he was in the line for CEO of WSM when shockingly they hired an outsider instead of promoting him. Friedman left immediately after that. It's just my speculation, but I think he had an axe to grind.

Gary Friedman leaves WSM (Gary Friedman leaves WSM)

In the end, he likely made the better move as he now owns 20% of a near $5 Billion company that he saved from near bankruptcy.

Friedman's experience at Williams-Sonoma, particularly in retail operations and brand development, is what helped spawn his later success in transforming and leading RH into a luxury home furnishings brand.

Under Friedman's guidance, RH has shifted its focus to become a luxury lifestyle brand. This strategic shift has involved expanding into different areas outside of home furnishings such as:

• Travel (with RH-branded guest houses and a yacht)
• Residential real estate (RH Residences)

Gary's bold growth strategy marked a major departure from its core furnishings focus.

RH's growth strategy has also involved a considerable investment in experiential retail, distinguished by awe-inspiring design galleries. This approach sets RH apart from Europe's luxury fashion houses that also offer home collections but may not invest as heavily in furniture-focused retail experiences.

RH's expansion into creating a comprehensive collection of luxury home furnishings has significantly increased its market share.

Financials

The company has seen a marked improvement in its financial metrics over the years. In 2008, RH did 32% gross margins. In 2023, margins had expanded to 50%. Over this time frame, sales grew from $722 Million to $3.6 Billion.

Net margins expanded from negative 4% to +20% over that time frame. RH's adjusted gross margin has increased significantly, demonstrating the brand's pricing power and the desirability of its offerings.

This financial success is underpinned by RH's focus on direct-to-customer sales, with very little of its business being cash-and-carry from its stores.

The company has had a rough go of it recently, much of it to blame on the rapid rise in interest rates, which has essentially shut down the home buying market, which is the impetus for a strong home furnishings market.

If you believe that rates will ease and that with each passing year, a new crop of home formations will inevitably cause pent-up demand for home furnishings, then RH will likely stand to rebound strongly.

If you compare the margins of the RH during a stronger housing market, it is on par with luxury brands like LVMH (OTCPK:LVMHF), Ferrari (RACE), and not too far behind Hermes (OTCPK:HESAY), all of whom sport net margins over 20%.

Expansion Plans

While RH has expanded into other areas like hospitality with RH Guesthouses and RH Residences and has also ventured into the realm of content with RH Media, these are relatively new developments and are more about enhancing the brand's luxury lifestyle offering than significant revenue drivers in comparison to their core home furnishings business.

Friedman has aspirations of building RH into one of the world's most prestigious brands, though. You can see that in the constant conversations he has on his conference calls about powerhouse brands like Louis Vuitton, Tesla, and Apple. Friedman has much bigger aspirations than just home furnishings.

From December 2018:

Like when you build an Apple or build a brand that's like so good or you even look, study LVMH. You look at LVMH, it's got a lot of businesses but I think, what, 60% of the profit comes from Louis Vuitton, right, or something like that. And so we sit here and we say, today, the opportunities that we're seeing by just focusing on RH and getting really, really deep into RH and thinking about how to amplify this brand, how to render it more valuable, what are the strategies, how important Interior Design is becoming to our business, how important Hospitality is becoming to our business, we're just so excited. We've never been more excited and optimistic about the future. How important international can be to this business, there's no competition over there.

Source: Q3 2018 Earnings Call

From December 2019:

I tell our team internally here that — and if you think about almost every — I think every luxury brand in the world today, all the best luxury brands, whether it's Hermès, Louis Vuitton, CHANEL, you name it, on and on, Christian Dior and all the others, they were all born at the top of the luxury mountain, right, they started there and we obviously didn't. And we're one of the few that is trying to make the climb to the top of the luxury mountain. And the people at the top of the luxury mountain, quite frankly, don't really want you to make that climb. They don't really invite you to their party.

You're not from the neighborhood. You don't have the background. And to make that climb, which — I don't know a brand that has from the level we started at.

To make that climb up the luxury mountain, you have to do things that create a forced reconsideration, right? You have to do things that force people to respect you, that force people to tip their hat, right? When the world was shrinking and closing stores, we're opening the most inspiring architectural environments in the history of retail and — or integrating hospitality into our galleries the way we have. And Guesthouse will be no different. It will be a magnificent statement of our brand. It will — we believe it will create a global conversation and set a new standard. And not only that, what happens when you do work like this is it challenges your organization in a way that kind of just executing the same thing every day doesn't, right?

It forces you to think differently. It forces you to reach higher. And that's why — by the way, why we started in New York. A lot of people said, like, “Gosh, why don't you open your first Guesthouse somewhere where everybody is not going to pay that much attention, where you can make mistakes, where the critics won't be so harsh?” And we more operate from the Frank Sinatra model and believe that if you can make it there, you can get anywhere. And that's why it's important to start in New York.

Source: Q3 2019 Earnings Call

Take, for example, the company's most recent opening in England, their first international opening.

RH England

RH England (RH England)

RH England, The Gallery at the Historic Aynho Park, opened on June 9, 2023. This 17th-century, 73-acre estate was restored and reimagined as a unique design and hospitality destination.

Located in a historic property in the Cotswolds, RH England represents the brand's most immersive physical expression to date:

• Luxury home furnishings
• Exclusive art
• Antiques
• Dining experiences including The Orangery, The Loggia, and The Conservatory
• Wine Lounge
• Tea Salon
• RH Interior Design Studio, offering professional design services.

RH England Orangery (RH England Orangery)

This opening marks the beginning of RH's global expansion.

While many retailers boast of a capital-light, franchise or licensing approach to international expansion, we believe the only way to build a brand and optimize the business globally, is to invest into, and control the brand in the same manner we do locally. With people who live and breathe our values, because it’s their values. People who will lead our cause and build our culture, because it’s their cause, and it’s their culture. We believe when you aspire to be the very best in the world, there are no shortcuts, and greatness can never be delegated, nor licensed or franchised.

Source: Q3 2023 Earnings Report

RH's next openings in Europe include:

• RH Brussels, The Gallery on the Boulevard De Waterloo
• RH Madrid, The Gallery on the Plaza Marques De Salamanca in the first half of 2024
• RH Paris, The Gallery on the Champs-Elysées in the fall of 2024

RH Paris

To give you a true sense of how grande the company's aspirations are, take a look at the RH Paris:

RH Paris is one building from the corner of the Avenue Montaigne, known as one of the most exclusive and luxurious arteries in the capital, and the chosen home of the major haute-couture brands such as Chanel, Dior, Vuitton, Celine, Saint Laurent, and many others. We believe the space we have designed for this location will position RH as a place- maker in the luxury fashion capital of the world. RH Paris will be a six-floor jewel-box connected by a dramatic, ornate scissor stair and a central glass elevator that will whisk you up to the fifth floor and rooftop Champagne & Caviar Bar, where you can take in views of the Eiffel Tower while enjoying our innovative menu featuring the finest Petrossian Caviars. You can also visit the second floor and dine in our dramatic atrium restaurant, inspired by the Grand Palais. With an onyx-carved bar, floors, walls and tables looking out into the beautifully landscaped courtyard with 30-foot ivy-covered walls, it’s like dining in a secret garden, erasing the noise and chaos of the outside world. Mark your calendars for early September, RH Paris will be an opening party you won’t want to miss.

When Gary Friedman took over RH, he repositioned it from a near-bankrupt business into a leading luxury home furnishings brand. He has since set his sights on the top of the luxury mountain.

The company's aspirations are to be amongst the group of luxury elite brands like LVMH and Hermes. Friedman intends to make this a luxury empire.

Risks

There are some risks. Namely, the company took on debt to acquire a lot of the properties it is opening. Should interest rates continue to rise, the interest on that debt could become onerous, and higher rates could lock out the next group of aforementioned home buyers.

Sales in the latest quarter were down 13% from the same period last year. The aforementioned luxury brands all have seen sales continue to go higher; however, RH sales dropped similar to other furniture retailers. So the market is saying not quite yet to RH being an exclusive luxury brand.

As the company put it in their earnings report:

With 82% of homeowners having mortgages below 5%, and 62% below 4%, we continue to expect the existing housing market to remain frozen until interest rates and/or home prices fall meaningfully. Additionally, the home furnishings market has become increasingly promotional, and we believe that will create a mix shift towards clearance products, pressuring gross margins. In light of the current market we are delaying the mailing of our RH Modern Sourcebook until the first quarter of fiscal 2024 when demand conditions will likely be more favorable.

Source: Q3 2023 Earnings Report

However, if things go right and these new openings boost sales, if rates flatten out and the pent up demand from new household formations improves housing, the company is in a great position to grow, pay down its debt, and generate substantial cash flow.

Conclusion

The company has guided to 20%+ operating margins, in line with luxury brands like LVMHF and RACE. The company stated that its long-term plan is “to open immersive Design Galleries in every major market will unlock the value of our vast assortment, generating revenues of $5 to $6 billion in North America, and $20 to $25 billion globally.”

Simple math suggests that if this company were to get to $15 Billion in revenues at 20% margins (i.e. $3 Billion), this company would likely be at least at a $60 Billion market cap. At a $4.4 Billion current market cap, the upside is pretty incredible if they can execute their plan.

Looking at price to sales, RH trades at around 1.3X sales. LVMHF is at around 5X sales, Hermes is at 13X sales, and RACE is at 13X sales. The market is skeptical that it is worth a luxury multiple partly because of how the company has operated in this recent period with higher rates.

However, just taking a look at some of the pictures and videos from RH England, their New York property, their Marin (California) property, and others, it is clear that this isn't your standard home furnishings brand.

I took the opportunity to purchase shares after the earnings drop. I like Friedman's skin in the game (he owns roughly 20% of the shares outstanding), I like Friedman's history of success not only at RH but also at WSM, and I love their brand strategy.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.