Are Restoration Hardware’s Mixed Signals a Problem?

Source: DesignMine

Restoration Hardware Holdings Inc (NYSE: RH) shares are trading at new highs after delivering one of the best quarterly reports of the season. The company’s comparable sales growth of 18 percent is atop the retail industry, and its direct-to-consumers approach with enormous catalogs has proved to be an excellent strategy for driving growth. Yet, insiders continue to sell and offer shares despite bullish long-term guidance. Therefore, how should you perceive these facts?

Never mind Restoration’s Hardware’s 57 percent increase in comparable-store sales over the last two years, or its 200 percent EPS improvement during the first quarter. Instead, focus on the long-term vision: The one that includes five new galleries this year after two years of zero store expansion, and another 25 locations being negotiated for future expansion.

This is a company operating in a niche luxury home-improvement market with aspirations of becoming a $4 to $5 billion a year company with operating margins in the mid-teens. Currently, Restoration Hardware has twelve-month revenue of $1.62 billion and an operating margin of 7.9 percent. Therefore, investors should note that there is room for a great deal of improvement, and stock gains if the company is successful.

Nonetheless, despite a market capitalization of $3.3 billion and the outlook for a much higher stock if the company’s goals are met, management continues to take advantage of its current stock price. For example, Restoration Hardware announced on Monday that it would offer $300 million worth of convertible senior notes due in 2019 with an option to sell another $50 million.

The company has less than $11 million on its balance sheet thus the logic behind this move is with reason, especially given its growth plan. The problem is that Restoration Hardware already has $302.6 million in short-term liabilities and total debt of nearly $150 million. Therefore, why put more pressure on the balance sheet?

Also, Restoration Hardware is now profitable, and can afford capital expenditures with its margins continuing to improve. So in many ways it appears management is taking advantage of a company valuation that would seem cheap if its long-term vision becomes a reality.

In addition to the notes and the raising of debt, investors should take into consideration the high volume of insider selling that has occurred in the last nine months. In September of last year director James Chu sold a near 4 million share stake. Then, in October director Eri Chaya and Chief Operating Officer Ken Dunaj sold 25,000 and 50,000 shares, respectively.

In April, Dunaj sold another 53,900 shares while directors Chaya, Carlos Alberni, and Thomas Mottola sold 14,000 shares, 350,000 shares, and 160,000 shares, respectively. Hence, the insider selling in Restoration Hardware has been significant to say the least. Meanwhile, the company continues to proclaim a long-term vision that suggests years of higher stock prices and continued fundamental growth.

With all things considered, Restoration Hardware is giving investors quite a few mixed signals. While insider selling can be meaningless, it is the number of different directors and executives that make it alarming. In many ways it seems that every time the stock gets a boost, insiders are there to take profits.

On the other hand, Restoration Hardware has given us no reason to doubt its growth plans as it continues to hit home runs with each and every quarter since its 2012 IPO. Also, shares are up sharply since directors and executives decided to sell their large stakes in the company.

Albeit, the selling activity and desire to take advantage of every pop in the stock seems very short-sighted, but at the same time may signal that something unknown is lingering around the corner. As a result, investors should express caution in Restoration Hardware, realize that shares are higher by 170 percent since its IPO, and monitor the trading behaviors of those who know the company best as a sign to downsize the investment or take profits altogether.

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