RH (RH) and Williams-Sonoma, Inc. (WSM), two of the prominent players in the home-furnishing retail industry, have been thriving because people working from home turned to home improvement projects amid the pandemic to facilitate the “new normal” way of living.

Both stocks generated decent returns over the past five years. While RH returned 341% over this period, WSM has gained 39%. In terms of year-to-date performance, RH is a clear winner with a 91.1% return versus WSM’s 27.4%. But which of these stocks is a better pick now? Let’s find out.

Business Structure and Latest Movements  

RH is an upscale home furnishings retailer, which was formerly known as Restoration Hardware Holdings. The company offers high-end home furnishings primarily through 68 galleries across major markets in the United States and Canada, and sells expensive luxury products. Consequently, its customers belong in the wealthiest segment of the population.

The increase in RH’s demand indicates that the affluent (RH’s key demographic) stuck-at-home consumers are still shopping and spending on luxury goods. “The booming real estate activity in second-home markets, an accelerated shift of families moving to larger suburban homes, and the uptick in homebuilding should drive increased spending in our market for an extended period of time as the cycle for purchasing and furnishing a home is anything but quick,” the company said in the second-quarter shareholder letter.

RH announced the opening of RH Marin, The Gallery at the Village in July this year. RH Marin is the newest physical expression of the RH brand and the first Design Gallery in California with an integrated hospitality experience. The company plans to grow through initiatives in hospitality, housing, and international development, eyeing the UK and European market.

WSM is a specialty retailer of high-quality products for home. The company primarily sells kitchen-wares and home furnishings through 616 retail stores, at the end of its second quarter. WSM distributes its products to more than 60 countries with brands including Pottery Barn, Williams Sonoma, West Elm, Mark and Graham, and Rejuvenation.

WSM launched a new collaboration with Ghetto Gastro in partnership with kitchen design and manufacturing company, CRUX, and also launched an exclusive holiday collaboration with entertainment icon, Dolly Parton in September. The company expanded its collaboration with acclaimed fabric, trim and wallpaper manufacturer, The House of Scalamandré. The new assortment features a collection of over 25 products.

Recent Financial Results

In RH’s fiscal second quarter that ended August 1^st 2020, revenue of $709.3 million remained relatively stable compared to the year-ago value of $706.5 million, despite temporary gallery closures due to the pandemic and lower demand in the Contract division due to a pullback in capital spending in the hospitality industry. The company’s EPS grew 30% year-over-year to $3.71.

The emergence of RH as a luxury brand generating luxury margins has arrived years sooner than expected. Adjusted operating margin increased 6.9% year-over-year to a record 21.8%. Total company demand surged 16%, while RH core demand grew 24% year-over-year. RH generated $218 million as free cash flow, doubling from the year-ago value of $109 million.

WSM’s net revenue growth of 8.8% to $1.5 billion in its second quarter was driven by a significant acceleration in e-commerce. E-commerce penetration reached an all-time high of almost 76% of total company revenues by growing 46% year-over-year. Non-GAAP EPS of $1.80, more than doubled year-over-year.

Comparable brand revenue grew 19% year-over-year. WSM reported a non-GAAP operating margin of 13.1%, nearly doubling from the year-ago value and recording its highest quarterly operating margin performance. The company generated $216.4 million in net cash provided by operating activities, compared to the year-ago $26.6 million cash used in operating activities.

Here RH is in an advantageous position.

Past and Expected Financial Performance

RH’s revenue and EPS grew at a CAGR of 3.1% and 669.1%, respectively, over the past 3 years.

The market expects the company’s revenue to increase 22.5% in the current quarter, 5.7% in the current year, and 8.8% next year. RH’s EPS is expected to grow 85.7% in the current quarter, 43.9% in the current year, and 9.3% next year. Moreover, its EPS is expected to grow at a rate of 21.1% per annum over the next five years.

On the other hand, WSM’s revenue and EPS grew at a CAGR of 5.4% and 14.4%, respectively, over the past 3 years.

The market expects WSM’s revenue to increase 9.8% in the current quarter, 6% in the current year, and 1.3% next year. The company’s EPS is expected to grow 47.1% in the current quarter and 30.4% in the current year, but decline 3.3% next year. However, WSM’s EPS is expected to grow at a rate of 9.4% per annum over the next five years.

RH has an edge over WSM here as well.

Profitability

WSM’s trailing-12-month revenue is 2.4 times of what RH generates. But RH is more profitable with a gross profit margin of 43.6% versus WSM’s 36.4%. Moreover, RH’s ROA of 10.1% compares favorably with WSM’s 8.6%.

Valuation

In terms of forward P/E, RH is currently trading at 24.31x, 63% more expensive than WSM which is currently trading at 14.91x. Moreover, WSM is less expensive in terms of trailing-12-month P/S (1.21x versus 3.08x), but its forward PEG of 2.53x is 89% higher than RH’s 1.34x.

In terms of trailing-12-month price/cash flow as well, RH’s 21.50x is 151.2% higher than WSM’s 8.56x.

RH looks much more expensive compared to WSM, but it’s worth paying this premium considering RH’s high-quality business and higher earnings growth potential.

POWR Ratings

Both RH and WSM are rated “Buy” in our proprietary POWR Ratings system. Here are how the four components of the POWR Ratings are graded for RH and WSM:

RH has an “A” for Trade Grade and Industry Rank, and a “B” for Buy & Hold Grade and Peer Grade. In the 69-stock Home Improvement & Goods industry, it is ranked #7.

WSM has an “A” for Trade Grade and Industry Rank, a “B” for Buy & Hold Grade, and a “C” for Peer Grade. It is ranked #25 in the 69-stock Home Improvement & Goods industry.

The Winner

While both RH and WSM are good long-term investments considering their market dominance, continued expansion, and consumers’ focus on home improvement and renovation, RH appears to be a better buy based on the factors discussed here.

While WSM is a relatively cheaper option to bet on the immense growth potential of the industry, RH is growing rapidly and its premium valuation is justified as it has more room to grow its earnings.

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RH shares were trading at $410.89 per share on Monday afternoon, up $2.81 (+0.69%). Year-to-date, RH has gained 92.45%, versus a 13.81% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...

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