Restoration Hardware CEO defies 'current conventional wisdom' that retail stores are dead

March 28, 2014

With retailers from Wal-Mart to Staples talking about building smaller stores, you’d think that’s the direction the industry is heading. Until you see what Restoration Hardware is doing.

Restoration Hardware shares on Friday surged up to 14% in their biggest daily percentage gain since June after the retailer of luxury home furnishings erased fears that it would follow other retailers and report disappointing results after a shorter holiday selling season and wintry weather that led to store closings.

Instead, it reported a fourth-quarter profit in line with its prior forecast and gave a first quarter outlook that topped Wall Street expectations. Its fourth-quarter comparable brand sales rose 24%, leading to a full-year gain of 31%, its fourth-straight year of a comparable sales gain above 25%. In comparison, its rival and Pottery Barn parent Williams-Sonoma, also an industry outperformer, reported a full-year increase of 8.8%. Restoration Hardware also hired an industry veteran to a newly created position overseeing its international expansion opportunities.

“This is a company that’s doing to the home furnishings space what Ralph Lauren did to apparel in the 80s,” said Hedgeye analyst Brian McGough in an interview, adding the stock is his favorite among his coverage universe of over 100.  “They are addressing all the needs of the consumer in home furnishings space at the higher end. The space has never been rolled up before. They are doing it organically. We are talking about a company that’s got a 2% share in the home furnishings market.”

McGough sees the company’s annual per-share profit to grow 40% to 50% the next five years. He has a $200 price  target on the stock over the next three to five year period.  The majority of 12 analysts covering the stock rate it a buy, FactSet data show.

Since Restoration Hardware went public for the second time in November 2012, its stock has more than doubled. It was most recently up 12% to $71.14.

“We continued to outperform the home furnishings industry by a wide margin,” said Chief Executive Gary Friedman, a former executive at Gap and Williams-Sonoma.  “We continued to take market share.”

How does he do it? He first transformed Restoration Hardware  into a curator of luxury furnishings by targeting people with household income of over $200,000, a departure from the company’s prior iteration as a purveyor of tchotchkes.

He also closed some stores and opted to open larger-format locations, called design galleries, that are at least 20,000 square feet and feature furniture and other products in upscale living settings.  The company, for instance, last year opened a “gallery” at the Boston Historic Museum for Natural History.

“Over the past three years, we’ve continued to innovate, test and prove that we can build a retail experience that defies the current conventional wisdom that everyone is moving to the Web and retail stores are dead,” Friedman said on a call late Thursday. “We have proven just the opposite and continue to develop new and  more exciting  concepts  that will create an even more compelling and highly experiential environment for our customers.”

Friedman said the company learned last year that Restoration Hardware could build a win-win relationship by working with developers and moving from a tenant who occupies high-cost interior mall space or street space to positioning itself as a “next-generation” anchor tenant who can help transform the mall or a neighborhood. He said that’s allowed the company to take unique and dominant location “with substantially improved economics.”

While less than 20% of its assortment is displayed at its traditional smaller retail stores, he said goods that are showcased in stores experience a 50% to 150% lift across all channels.  At its five existing design galleries in cities including L.A. and  Houston, sales continue to top its projection of $850 in sales per square foot of selling space, with some markets seeing more than $2,000. Hedgeye’s McGough said it can feature 40% of assortment in stores 20,000 to 25,000 square feet in size; and 75% at stores 50,000 square feet in size.

He also opted to print thicker catalogs. The Spring 2014 mailing will include 13 books totaling nearly 3,200 pages, compared to six  books totaling 1,600 pages a year earlier. The new catalogs will be mailed through UPS, allowing the company to better communicate with customers and avoid damage or loss.  The cost per circulated page is actually lower than a year ago after the company eliminated the mailing it sent out later in the year, he said.

“We’re willing to destroy today ‘s reality to create tomorrow’s future,” he said, adding the $1.6 billion company has the potential to grow into a $4 billion to $5 billion business.