RH gives good reason to get defensive

RH confirms retail trends are worsening

RH (NYSE:RH) was one of the biggest winners from the pandemic boom and now it is one of the biggest losers of the pandemic bust. More importantly, because of when it reports in the reporting cycle, it has provided insight into the upcoming quarter and what to expect from guidance among S&P 500 companies. The company shocked the market with its earnings report just a month or so ago, not because it missed expectations but because it lowered its outlook on softening demand trends, loss of market share, and other near-term headwinds to growth. Now, the company has lowered its outlook yet again and we think this is a trend that will be echoed across the consumer discretionary space. Given the fact that the Consumer Discretionary sector is expected to post a robust rebound later this year and next year, we don’t think this is good news for the market at all. Not one bit.

RH trims guidance, shares fall

RH lowered its guidance for 2022 revenue to a range of -5% to -2% which is down 400 basis points at the top end of the range and 500 basis points at the bottom which we view as opening the door to unexpected weakness later in the year. As for earrings, the company is expecting the margin to contract another 200 basis points versus the previous guidance and we see risk in this figure as well. Not only is the company faced with declining sales but deleveraging as well due to the spending shift we expect to occur over the next two quarters. The FOMC is expected to hike rates by at least 125 basis points over the next two meetings on top of the increase in gas prices and that is going to cut deeply into consumer spending. Looking at the latest PCE data, the pace of wage growth and spending is down on a YOY basis which suggests the slowdown in spending is already here.

Gary Friedman, Chairman and CEO of RH, stated, "With mortgage rates double last year's levels, luxury home sales down 18% in the first quarter, and the Federal Reserve's forecast for another 175 basis point increase to the Fed Funds Rate by year-end, our expectation is that demand will continue to slow throughout the year.”

The only good news is that FQ2 results are expected to be in line with previous guidance but there is risk in this outlook as well. The company says unexpected backlog reduction is driving strength in the quarter which ultimately means less business and the possibility of outsized inventory builds later in the year.

The analysts weigh heavily on RH price action

The analysts are still rating RH a Moderate Buy and have the consensus pegged by $371 but don’t read too much into that. The sentiment may be holding steady but the price target is not and we don’t expect to see it bottom any time soon. The Marketbeat.com consensus price target is down nearly 50% over the last year and 32% over the last month on a wave of price target reductions sparked by the guidance update. The update precipitated 10 price target adjustments that see the sock trading closer to $350. The takeaway here is the low end of the range just got lower and it is only a smidge above the current price action. Assuming the company’s business deteriorates further, we see the low end of the range dropping significantly by year-end.

Turning to the chart, RH looks set to revisit the post-COVID low near $75. That is a decline worth 65% to current shareholders and is not a risk we are willing to take. The stock may bottom before then, possibly by the end of the summer and/or the next reporting period, but we think a change in market fundamentals will be required to make it happen and we don’t think that is in the cards. We do think, however, that defensive stocks that offer value and yield like General Mills are the way to go.