Insights

Why the CEO of This Buffett Stock Is Playing the Long Game

Just as many companies thought they were past the period of pandemic-induced sales declines and starting to climb back up, they are now faced with supply chain woes, too much inventory, and high inflation. Many retailers have been responding to these issues by slashing prices to sell down inventory so they can start over with improved supply chain processes in place.

Luxury furniture retailer RH (NYSE: RH), though, is going against the grain. It’s sticking with its long-term brand strategy and shunning price cuts despite the sales declines that may result from diminishing demand. Investors should cheer this decision.

Record sales, revised outlook

For RH, 2022 started out looking like it would be a strong year. Sales increased 11% year over year in the first quarter to a record $957 million, and earnings per share jumped 190% to $12.16. Its gross margin expanded by 4.8 percentage points to 52.1%, but its operating margin narrowed by 0.4 percentage points to 21.4%. Adjusted operating margin, which accounts for expenses related to certain store openings, expanded by 2.1 percentage points to 24.7%.

With pressure building, management guided for a slight year-over-year dip in sales for the second quarter, and about flat sales for the year. It also said it expected an adjusted operating margin of 23% to 24%. But it recently amended that to a 2% to 5% decline in sales and an adjusted operating margin in the 21% to 22% range.

RH stock tumbled on the news, losing 7% of its value in one day. But it’s actually up 22% since that low, even though it’s still down 50% for the year. 

Short-term pressure, long-term gains

Companies like Target, Walmart, and many others have announced plans to clear out their inventory and bring in more revenue through price cuts. But for discount retailers, further slashing prices doesn’t affect their branding or image. RH has developed itself as an upscale niche retailer with exclusive products geared toward highly affluent patrons. Putting its products on sale could be a salve for the pain it faces in the coming quarters, but it could also cause lasting damage to its brand.

“There may be short-term risk of market share loss by choosing not to promote,” said founder and CEO Gary Friedman. “We believe there is certain long-term risk of brand erosion and model destruction once you begin down that path.” To be sure, RH’s target customer is not likely to be swayed by cheap prices in any case. Putting products on sale would simply open it up to a somewhat wider range of clientele. But it would do little to further the company’s vision of being a global luxury brand.

In another interesting point, Friedman said he anticipates RH will “shed less valuable market share as we continue to raise our quality” over the next few quarters. As consumers tighten their wallets, RH is likely to lose some of its less affluent customers, but it’s betting on a strong brand to carry it through with its core customer base.

What does it mean for RH stock?

Over the past five years, RH stock has gained a fantastic 250%. No less an investor than Warren Buffett has added shares to his portfolio.

Although the stock is down sharply this year, the company has a great deal of potential. It’s opening new galleries in the U.S. and is entering Europe as well — its first foray into international markets — and it’s doing so in a big way. Its first overseas gallery store will be situated in a historic house on a 73-acre estate in the English countryside. The company is moving forward with its hotel, yacht, jet, and restaurant branded experiences as well.

I think the decision not to compromise on its branding should inspire a lot of confidence — and it looks like a lot of other investors agree in that the stock is back up a bit in recent weeks. However, the shares are still trading at less than nine times trailing 12-month earnings, which looks like an excellent value.

Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends RH, Target, and Walmart Inc. The Motley Fool has a disclosure policy.

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