Interest Rates Begin to Affect High Income Consumers, as Evidenced by Slower Demand at RH

We plan to lower our $421 fair value estimate for no-moat RH (RH) by a mid-single-digit rate after incorporating a slower outlook for fiscal 2022. The firm pointed to full-year sales declines of 2%-5%, down from early June guidance of 0%-2% growth, and under the more than 3% expansion we had forecast. Higher interest rates were noted as the main culprit, with mortgage rates around twice last year’s levels acting as a drag on high priced home sales. With a Fed intent on nipping away at higher inflation imminently, we don’t think this exogenous headwind will ameliorate over the next few quarters, weighing on the consumer’s willingness to spend. The updated full-year outlook implies a high-single-digit percentage sales decline in the back half of 2022, which would still represent a sales increase over the second half of 2020, when sales grew more than 20%. For reference, even with this downtick in demand, RH is likely to generate second-half sales nearly 30% higher than the second half of 2019—prior to the pandemic.

With lower sales generally comes lower cost absorption, and RH has refined its outlook to include a 21%-22% operating margin, lower than the 23%-24% it previously had indicated and under our 24% estimate. But we contend this still represents a best in class retail margin (as the company is still largely capturing sales from its retail offerings), and language surrounding the unwillingness to promote despite headwinds implies to us the brand will remain well positioned exiting the currently uncertain economic environment. After altering our 2022 projections, our 10-year average sales growth projection of 7% will remain unchanged, supported by a pipeline of new and innovative offerings and adjacent market projects. As such, cost absorption should normalize over time, offering RH the ability to average 25% operating margins. After falling at a mid-single-digit clip after the 2022 update (to around $224), we still view the shares as attractive.