Dive Brief:
- S&P Global Ratings lowered its issuer credit rating on luxury furniture maker RH to BB- from BB on Thursday. The lowered rating reflects that the retailer’s “prospects for fiscal 2023 are weaker than we previously anticipated as home-related discretionary spending weakens.”
- The company’s international expansion and gallery remodel initiatives will require significant capital spending of about $275 million, S&P said. The agency also lowered its rating on RH’s secured debt to BB-; however, S&P still expects a meaningful recovery in the event that RH defaults.
- RH had $1.45 billion outstanding under its share repurchase program as of Jan. 28 according to S&P, which said recent declines in the company’s share price incentivize RH to continue its share repurchasing.
Dive Insight:
RH is likely to experience weaker financial performance through 2023 as a result of ongoing muted consumer demand in a difficult macroeconomic environment. Higher interest rates and a weak housing market are also likely to be contributing factors that will lead to a projected 19% decrease in revenue.
S&P also said it revised RH’s financial risk profile assessment to significant from intermediate. But financial pressure on the home furnishings sector is also likely to be temporary.
“We believe inflationary pressures will continue to drive lower consumer discretionary spending at least over the next 12 months. While this will likely be less pronounced for more affluent consumers, we still anticipate reduced propensity to spend for this demographic,” S&P said.
Within the home sector, “we think abundant spending in recent years has satiated demand. Meanwhile, rising interest rates have led to fewer home sales, which dims prospects for higher demand for home furnishing products.”
Despite those concerns, improved brand recognition means RH has a large customer base to lean on as pressures ease and demand returns. “This should lead to a recovery following the steep decline projected in 2023, with modestly positive revenue growth in 2024,” according to S&P.
RH reported $3.59 billion in revenue for the 2022 fiscal year, down from $3.76 billion the previous year, with an adjusted operating margin of 22% and EBITDA margin of nearly 26%. That is “the most profitable business model in our industry,” CEO Gary Friedman said in the company’s 2022 fiscal year report and shareholder letter.
“It’s clear that the stay-at-home restrictions of the pandemic created an exponential lift for home-related businesses, and it’s also clear the lift, like the pandemic, was a temporal isolated event versus something structural or systemic,” Friedman said. “We believe the questions are, what if anything has permanently changed? What brands and businesses are positioned to win over the next decade, and what data is important to determine who those winners will be? These are not easy questions to answer in light of the massive backlog relief and a return to discounting at most home furnishings retailers, which distort short-term results.”
The retailer said business conditions will likely remain challenging for the next several quarters and possibly longer. That’s due to accelerating housing market weakness, uncertainty generated by the recent banking crisis and the cycling of record COVID-driven sales and backlog reductions. RH’s guidance for the 2023 fiscal year projects revenue ranging from $2.9 billion to $3.1 billion. This fiscal year includes a 53rd week for accounting purposes; the extra week is expected to generate an additional $60 million for the company.
RH acquired two companies in December for an undisclosed amount – upholsterer Dmitriy & Co., and custom furniture company Jeup, Inc. RH created two new businesses, RH Bespoke Furniture and RH Couture Upholstery, in conjunction with the acquisitions, the company said at the time.
RH in recent years also stepped outside of the furniture and home space and began offering high-end, hospitality and travel experiences aboard private jets and a yacht. These initiatives are part of a strategy to diversify its revenue streams, the company said in its shareholder letter.
S&P cautioned it could further lower its rating if RH’s operating performance falls below expectations, resulting in lower revenue, earnings, and free operating cash flow or if the company pursues share repurchases more aggressively. S&P could upgrade its rating if operating performance stabilizes and if the company maintains sufficient cash on its balance sheet to preserve financial flexibility while business conditions remain uncertain.
