Is Restoration Hardware a Fixer-Upper? 5 Things to Know

Restoration Hardware Holdings' stock has been a stunner since its 2012 IPO. It had doubled since May so a recent pullback was to be expected. Is it still a good house in the upscale home-goods neighborhood? Here are five things to consider.

Room at the top
The company recently reported and the stock sunk. However, it wasn't reacting to earnings, not after 15 straight quarters of double digit revenue growth, raised guidance, and margin expansion. The departure of co-CEO Carlos Alberini to head Lucky Brand took it down.  Alberini explained that at age 59, and with a long-held desire to run a company, Lucky was an opportunity too good to miss.

Concern over top management lingers as Alberini was credited as the day-to-day operations man. The Wall Street Journal also characterized Alberini as the more numbers-oriented guy. Current co-CEO and founder/curator Gary Friedman only returned to his job in July after a ten month board investigation into an inappropriate employee relationship.

CEO Gary Friedman

source: his Letter from the Chairman Emeritus

Friedman tends toward high-flown rhetoric and the unconventional. Since his return he has announced the company's entrances into the contemporary art market, music, and hotels. He also replaced the marketing department with a Truth Group. In a letter from the Chairman Emeritus he wrote:

We decided to eliminate the marketing department in favor of having a Truth Group, as marketing can at times be manipulative. We said to ourselves, if we are doing things we're truly passionate about, we don't have to worry about marketing campaigns.

Friedman is the brand and the man who staved off bankruptcy. Alberini will stay on the board but the company needs a day-to-day manager and has no replacement yet.

Macy's should be worried
On the second quarter call Friedman detailed the company's move into apparel as well as mentioning over thirty offers from prime malls to add Restoration Hardware to their top-tier locations.

Apparel and home goods is Macy's bailiwick and its higher-end Bloomingdales stores would feel the most impact from Restoration Hardware with its luxury high-end furnishings and apparel. Restoration Hardware morphing into a quasi-department store is a definite possibility.

At the Goldman Sachs Global Retailing Conference in September,  Friedman said, "We've long said that we believe we can curate a world far beyond the four walls of the home." Macy's, watch out.

So should Williams-Sonoma
Before Restoration Hardware Friedman was President of rival Williams-Sonoma . When he took the job as CEO of 'Resto' (as the company is known around the office) it was near bankruptcy. Friedman poured in $4.5 million of his own money (he is still the largest individual shareholder) and jettisoned fully half of Restoration Hardware's inventory to focus on high-end furnishings.

Williams-Sonoma owns Pottery Barn, West Elm, and Rejuvenation and competes in the $143 billion U.S. home-furnishings business. Restoration Hardware's outgoing Alberini said, "half of that spend is controlled by the affluent," the company's core customer.

Williams-Sonoma has 581 stores and seven e-commerce websites. It is a stable company with a yield of 2.10%, very little debt, and a very good corporate-governance risk rating of 1. Restoration Hardware has total debt of $134.49 million to $8.2 million cash and a corporate-governance risk rating of a high 7, mainly for compensation and shareholder rights.

Williams-Sonoma should be worried. During Friedman's 13-year tenure there he helped grow revenue at Williams-Sonoma almost ten-fold, and twenty-fold at Pottery Barn.

Location, location, location
Now, Restoration Hardware operates 84 stores which include 14 outlets in the U.S. Friedman said, "We have a five billion dollar company trapped in a billion dollar real estate."  He means that the company has the product assortment to fill five billion worth of real estate. The company plans to turn the 70 legacy stores into 45,000 square foot full-line locations like the five currently in major cities.

Similar larger-footprint openings have seen 50%-150% sales improvements. Management fully expects these to lift the company to a double-digit net operating margin from its current 8%.

The man with the blueprint
Friedman is an intrinsic and inextricable part of Restoration Hardware. Former boss and retail wizard Mickey Drexler told the San Francisco Chronicle, "He took a substantial risk with a major reinvention of Restoration Hardware. He basically took a moribund business and made it a relevant business." 

As Chief Curator, Friedman is very hands on, personally sourcing artisan furnishings and objets d'art. He was most recently involved in the restoration of the Historic Museum of Natural History into the Boston flagship gallery below.

Read any earnings transcript and a drinking game is easily possible with the word 'curate'. You gotta admire someone who says, "Let's make this really personal and do what we love. And if we go down, we go down in style."

Fixed up and ready to buy?
Friedman has truly fixed up Restoration Hardware. It was a penny stock before Friedman rode in on his eggshell-white horse. It is speculative but high-growth compared to Williams-Sonoma or Macy's with a forward P/E of 12.04 and a yield of 1.90%.

The risks are not finding a co-CEO to balance Friedman and brand extensions into apparel and art being too pie-in-the-sky. At the very least, Restoration Hardware is a better house than it was and in a nicer neighborhood.