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The following segment was excerpted from this fund letter.
RH (NYSE:RH)
Over the past decade, there have been a lot of companies that have been pitched as quality compounders. We’ve seen the market test a lot of these companies in recent quarters. Just like in the beginning of the 2000s, those that not only survive, but thrive, become truly great businesses. But most of them will not only not be able to continue investing in their business and opportunity set, but they may not even make it. Difficult circumstances are essential tests to the durability and quality of a business.
Gary Friedman, the owner manager of RH, has been talking about the company climbing the luxury mountain over the past few years. Wall Street is skeptical RH can hold its leading margin profile after elevated demand during Covid, and it surely doubts that it is a luxury company, at 10x earnings. We’ve been looking to get involved in the housing ecosystem given the dramatic selloff in the sector over the past year, and our first investment here is via RH.
Demographically, we expect US household formation to remain very strong after a decade of underinvestment in housing supply. Gary strategically with-held new product launches in the aftermath of Covid, when times were easiest, and is now releasing a new premium product lineup. We believe there is a lot of latent pricing power in home furnishing, and while high interest rates are trapping people in a home they would otherwise possibly leave, we believe the consumer, particularly the high-end consumer, will look to continue to upgrade their homes.
The truest test of Gary’s quest to make RH a true luxury company is in fact a recession. One of the reasons why there are few, if any, American luxury businesses, is that without a family controlling the company, optimizer-oriented management teams cannot withstand the pain that comes from not discounting a product line into weak demand. We can’t recall a single American company that has “destroyed” inventory like the French luxury companies in the face of a recession. Many have tried. Few, if any, have succeeded.
Anchored by Gary’s 21% ownership of the company, RH has a good chance. And not only is it not tempted in the current volatile environment to discount, but he is actually raising price. With a buyback authorized for over 30% of the shares outstanding, Friedman is also not shying away from making bold investments in the current environment. He is aggressively expanding galleries and introducing new marquee Europeans properties.
The combined product launch cadence, increased prices, aggressive footprint investments and forthcoming share repurchases, not to mention low valuation, made us move off the sidelines and take a position in RH. While we are certainly not hoping for a recession, we are excited that such an environment could solidify Gary’s mission to make RH a rare American luxury brand.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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