RH: Ongoing Product Rationalization Affects Results

No-moat

Furthermore, the company narrowed its outlook for earnings per share to $0.03-$0.05 from $0.02-$0.06, indicating that despite faster-than-anticipated sales, RH has been subject to increasing gross margin pressure. It noted that higher outlet sales and related markdowns and inventory reserves were the culprit, indicating pricing power is difficult to glean; this supports our no-moat rating. While gross margins could still be ahead of last year's depressed 30% level in the first quarter, we still expect them to be widely behind the three-year first-quarter average of 34% that was generated over 2013-15. We don’t anticipate any material change to our $46 fair value estimate and view the shares as overvalued, trading at more than 25 times forecast 2017 EPS.

Our long-term outlook still includes high-single-digit top-line growth, contingent on continued square footage expansion, along with 250 basis points of selling, general, and administrative expense leverage and 300 basis points of gross margin expansion, leading to operating margins that reach above 10% from our 6% forecast for 2017.

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