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I am of the opinion that RH’s revenue has the potential to experience significant growth over the next decade, despite recent declines in revenue due to macro uncertainty. In this article, I will discuss the factors that drive revenue and the associated risks.
Compared to its peers, RH has seen larger declines in revenue for two main reasons. Firstly, in the past couple of years, RH’s revenue growth has significantly slowed down, and in Q2 2023, revenues declined by 20%. This decline was initially caused by supply chain difficulties resulting from the pandemic, as RH struggled to meet the increased demand caused by stimulus packages. In 2022, trends started to soften due to inflation and macroeconomic factors, leading to a decrease in demand. I believe this declining demand was masked by the supply chain issues, which caused RH to report higher revenues as they fulfilled orders from previous quarters to catch up. This has resulted in a sharp decline in revenues for 2023 compared to a more gradual decline over the two-year period.
Secondly, RH has not executed its strategy to its full potential. In 2016, RH reduced its gallery opening frequency to three galleries per year in order to restructure its logistics platform. Although the cadence was raised back to five galleries per year in 2019, the openings have been hindered by the pandemic, construction delays, and lack of new products. This poor execution has led to only four galleries being opened since 2020. On the Q2 2023 call, CEO Gary Freedman acknowledged these execution missteps, and I believe that RH’s execution will improve and drive growth over the next decade.
Revenue Drivers
Gallery Transformation: RH believes it can achieve $5-$6 billion in revenue in North America, but I believe this estimate understates its full potential. When Gary Freedman took over RH in the early 2000s, the company had 106 legacy galleries. Since then, the number has decreased to 81, with 28 being Design galleries and 35 remaining as legacy galleries. Over time, RH has the potential to reach 60-70 design galleries, which I believe could result in a $2 billion opportunity by replacing legacy galleries with design galleries, based on the increase in revenue per square foot. RH has reported a 100% uplift in sales when they open a design gallery in a market where they had a legacy gallery before. I believe RH can return to opening 4-5 galleries per year. In Q1, RH stated that they have 12 North American galleries in development scheduled to open in the next few years, resulting in an average of 4 galleries per year. In addition to the $2 billion opportunity from gallery transformations, I believe RH has incremental opportunities with smaller design studios in smaller markets. RH already has a few of these, such as the East Hampton location, and they have identified 40 additional locations. Although the quantifiable impact is uncertain, I believe this can provide additional revenue to the $5-$6 billion target, as well as providing data to potentially open larger design galleries in the future.
Product Elevation: Despite short-term pricing challenges due to what Gary Freedman described as “arrogant pricing,” I expect RH to be successful in raising prices in the long term, although at a slower rate than in previous years. As RH climbs the luxury mountain, they have released new higher quality collections such as RH Contemporary and RH Modern, which have commanded higher prices as the brand gains recognition. RH Modern, on average, had 50% higher prices than RH interiors, while RH Contemporary was 35% more expensive than RH Modern. However, there have been difficulties in this process. RH Contemporary was delayed three times due to manufacturing partner constraints, which impacted demand for RH this year. In Q2, CEO Gary Freedman acknowledged the challenges and stated that they have learned from them and will improve. In the second half of 2023, RH will be launching 70 new collections, resulting in 80% of products being new. This will transform the value proposition with lower prices and higher quality. I expect this newness to attract a wide range of customers and allow RH to gain market share from both the high end and the low end of its target market.
International Expansion: I believe that RH has significant opportunities for international expansion, which will drive the majority of its growth over the next 10 years. RH estimates that the international opportunity is $20-$25 billion in revenue. With the global furniture market valued at $550 billion according to Statista, there is ample room for RH to grow from its current international presence. RH launched RH England in June 2023, two years later than initially planned. This delayed launch allowed RH to ensure that the gallery was exceptional and positioned for success. However, RH England is not representative of the potential economics in Europe, as it is located far from convenient areas unlike other RH galleries. Instead, RH plans to open four smaller-sized galleries (15-20k sq ft) in Europe over the next 18 months, followed by four larger galleries in 2025. Over time, I expect RH to open five international galleries per year, similar to the US. Unlike the US, these international galleries will not be replacing legacy galleries, resulting in roughly double the revenue growth rate. I also believe that these stores have the potential to be significantly more valuable than incremental US stores, as they will introduce the RH brand to entire countries instead of just states.
In conclusion, I believe that despite recent revenue declines, RH has the potential to experience significant growth over the next 10 years. The drivers of this growth include gallery transformations, product elevation, and international expansion. However, there are risks associated with supply chain difficulties, execution missteps, and pricing challenges. Overall, I am optimistic about RH’s future prospects.
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