RH Stock Sinks on Lower Guidance. Is It Time to Buy the Dip or Run for the Hills?

Key Points

• RH shares fell after the company cut guidance.

• The company is making a big push into Europe, which thus far looks on track.

• The stock isn't expensive, but a lot of unanswered questions remain.

• 10 stocks we like better than RH ›

Shares of luxury furniture company RH (NYSE: RH) sank after the company lowered its full-year guidance due to the impact of tariffs. The stock is down more than 40% for the year.

Let's take a close look at the company's recent results to see whether investors should buy the dip or stay away.

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Tariff troubles

It's been a difficult environment for furniture companies, as a pull-forward in demand from the COVID-19 pandemic, together with low housing turnover due to high interest rates, has weighed on the industry. The implementation of tariffs only added to the industry's woes, and in late August, the Trump administration said it could tack on additional tariffs aimed specifically at the furniture industry.

For its fiscal Q2, RH reported a more than 8% increase in revenue to $899.2 million, while demand increased by 14%. This number can differ from revenue based on when products are delivered. Adjusted earnings per share (EPS), meanwhile, soared 73% to $2.93. Analysts, however, were looking for EPS of $3.21 on sales of $905.3 million.

The company's foray into Europe continues to do well. RH England, which is in its second year, saw Gallery demand surge 76% and online demand increase by 34%. It expects Gallery demand to range between $37 to $39 million this year, with online demand hitting about $8 million. Meanwhile, it opened RH Paris earlier this month.

Gross margins were solid, increasing 30 basis points to 45.5%, while SG&A (selling, general, and administrative) expenses were largely kept in check.

Merchandise inventories rose 4% to $957 million from $917.3 million a year ago. That was below its sales growth. The company said it plans to wind down $300 million in excess inventory in the coming 12 to 18 months.

In the past, RH had aggressively bought back $2.2 billion worth of its stock, which has left it with $2.5 billion in debt. This, together with its very expensive lease commitments for its galleries, puts pressure on the company to avoid a prolonged slump. RH generated negative free cash flow last year, but has so far produced $114.8 million this year and is projecting to be between $250 million to $300 million for the year. However, that is down from an earlier outlook of $250 million to $350 million.

RH sources most of its furniture from Asia, but is moving a significant portion of its upholstered furniture to a factory it owns in North Carolina. It sees 52% of its upholstered furniture being produced in the United States by the end of this year, with 21% coming from Italy and 12% from Mexico. However, it said there is no workforce in place for the industry to move wood and metal furniture back to the U.S.

Looking ahead, the company lowered its full-year revenue growth to between 9% to 11%, down from an earlier outlook of growth between 10% and 13%. It also reduced its adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margin guidance from 20%-21% to 19%-20%, as it sees an addition $30 million hit from tariffs.

For Q3, meanwhile, it expects revenue growth of between 8% and 10%.

Image source: Getty Images.

Is it time to buy the stock?

RH is making a big bet on Europe, and so far, things appear to be going well. RH England is a huge gallery in the countryside, and is on track for some impressive sales. The company is going big when it comes to its European expansion, with some large grandiose, upscale galleries, so it has a lot riding on this.

Meanwhile, the ebb and flow of tariffs is having a big impact on the company, and could have an even bigger one in the future. It's vulnerable to any additional tariffs placed on furniture, in addition to the country-specific ones it is already dealing with. However, it would be a major beneficiary if the Supreme Court struck tariffs down.

For a valuation perspective, RH trades at a forward price-to-earnings ratio (P/E) of only 15 times next fiscal year analyst estimates. The problem is the earnings part of the ratio could fluctuate a lot, depending on what happens with the tariff situation. Meanwhile, the company is already carrying some pretty hefty leverage.

RH looks interesting at current levels, but it certainly falls in the high-risk, high-reward bucket.

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool recommends RH. The Motley Fool has a disclosure policy.