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RH Finds Inspiration In Berkshire, Apple And Louis Vuitton Parent
Dec 08, 2018

Early this week, while the rest of stock market was tanking, luxury home furnishings retailer RH was basking in glow of a stellar third-quarter earnings report, handily beating guidance with a 70% gain in net profit and 8% jump in revenues.

The retailer has been firing on all cylinders. Chairman and CEO Gary Friedman has been saying all along that the focus this year would be more on bottom-line performance than revenue growth, and indeed, that’s how it has played out. Business model efficiencies have included a thorough overhaul of the backend, and that’s included consolidation of distribution operations and the closing during the quarter of another 500,000-square-foot distribution center in Baltimore. The moves, among other things, have reduced inventories, and the Baltimore closing alone is expected to save the company about $4 million a year.

That’s on top of $24 million in annual savings RH expects from a redesign of the overall RH organization, also streamlined for more collaboration and less of the bureaucracy that can put the brakes on a growth company.

These initiatives came as the Top 100 company continued investing in inspiring physical store experiences that include the opening of large stores this year in Portland, Ore.; Nashville, Tenn.; Yountville, Calif.; and New York — the latter featuring a rooftop restaurant the company expects will generate more than $15 million annually once it expands outdoor seating next spring.

But one of the most interesting takeaways from Friedman’s quarterly letter to shareholders is the color he offers on where RH itself has turned for inspiration. He mentions three companies: Warren Buffett’s Berkshire Hathaway (which happens to be the parent of other retail furniture stars: Nebraska Furniture Mart, R.C. Willey, Star Furniture and Jordan’s), Apple, and LVMH (short for luxury goods conglomerate LVMH Moët Hennessy Louis Vuitton).

Friedman said RH “spent years imagining a model that reflects the quality and characteristics” of these businesses, which it has studied and admired.

Here’s more on what he had to say about each one and the ways RH is learning from them:

He starts with LVMH, noting that, like the Paris-based company, “we are building a luxury platform, and in a similar fashion, we are beginning to demonstrate that we too can be rewarded with luxury brand margins that are double those of competitors targeting broader markets.”

Both LVMH and RH are beneficiaries of a compounding wealth effect, he said, noting how the stock markets huge gains over the past 12 years mirrored the gains in the number of households with incomes of more than $200,000, the kind of households that can afford what RH is selling.

Friedman said, “Building a luxury brand is extremely difficult, requiring decades of effort and a discerning level of taste, which is generally absent in businesses of scale,” and as he’s said in previous presentations, “there are those with taste and no scale and those with scale and no taste, and we believe the idea of scaling taste is large and far reaching.”

RH is similar to Apple in the way it is designing what Friedman called “a seamlessly integrated ecosystem of businesses.” Each part amplifies the brand and works to make the whole more valuable than the parts.

“As an example, our retail business is amplified and rendered more valuable by our interior design business — both are amplified and rendered more valuable by our physical galleries and real estate development business — and all are amplified and rendered more valuable by our hospitality business,” he said.

And finally in Berkshire, Friedman sees similarities in the way they’re building capital efficient business, with a lot of free cash flow, access to low-cost capital and cultures “relentlessly focused on (return on invested capital) and capital allocation.”

“Also like Berkshire, we invest with a long-term view, indifferent to short-term market swings or recessions, and believe every market presents opportunities."

He offered this quote from Buffett: “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outside with washtubs and not teaspoons.”

Just as Berkshire took advantage of bargains during the past recession, RH took advantage of the favorable capital markets in 2014 and 2015, raising some $650 million through zero-interest debt offerings “for one of those rainy days” and then using the money to repurchase its undervalued stock last year.

“Unlike Berkshire Hathaway, I don’t see us acquiring a large portfolio of businesses but rather staying focused on the growth opportunities in our current ecosystem,” Friedman said.

RH will continue accessing capital markets when favorable and will be disciplined in the allocation of its capital. And Friedman said it will use excess free cash flow to take advantage of real estate and other opportunities, including share repurchases.

But he may have to wait awhile on the latter. As I write this, the stock market is plunging again on fears the trade war truce with China may not be all it seemed to be from President Donald Trump’s comments following the Group of 20 meeting in Buenos Aires. The Dow Jones Industrial average is off 2.4%, or more than 600 points, after dropping nearly 800 points Tuesday.

RH stock was up 11.1% Tuesday and about 2.5% so far today.


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