ARHS - Arhaus: Growth Through Stores And Strong E-Commerce Channel Interactions

2024-01-02 23:41:36 ET

Summary

• Arhaus stock surged 38.30% since March, nearing a $12.94 target, suggesting a 7.3% upside.
• Business strengths lie in its 'directly sourced' model, online presence, and store growth strategies.
• Financially, positive trends in revenues and free cash flow, but caution is warranted due to stock volatility.

In March, I wrote an article on Arhaus, Inc. ( ARHS ), a lifestyle brand and omnichannel retailer of premium artisan-crafted home furnishings. I argued that Arhaus had a strong competitive advantage, a loyal customer base, and a solid growth strategy and was undervalued at its previous stock price. Since then, the stock has seen a serious upward momentum at 38.30%. The stock is now nearing its average price target of $12.94 , which implies a smaller 7.3% upside potential from the current level. However, I remain bullish on Arhaus as it continues to deliver EPS results above expectations; it is expanding its market share through its omnichannel growth strategy and appears undervalued relative to peers in the industry at a FWD price-to-earnings ratio of 14.39, which is lower than the industry median of 16.27. Therefore, investors may want to take a bullish stance on this stock.

Company updates

In my previous article , I gave an overview of the company. Arhaus, a lifestyle brand and omni-channel retailer of premium artisan-crafted home furnishings, went public in 2011. Arhaus has a competitive edge in the home furnishings market due to its business model based on 'directly sourced, often American', its strong online presence, and its distinctive brand image.

The company sources most of its products from local artisans and craftsmen , which gives it an advantage in terms of quality, sustainability, and supply chain efficiency. Arhaus also has an affluent and environmentally conscious consumer base that is growing, thanks to its digital and omnichannel strategy, its social media engagement, and its innovative and diverse product offerings.

Arhaus has four key growth drivers to expand its market share in the fast-growing and highly fragmented home furnishings industry. These are: increasing brand awareness through new showrooms, digital, direct mail, social media, and brand partnerships; growing the number of showrooms across the U.S.; enhancing its product portfolio with new collections and categories; and investing in its systems and infrastructure to support its growth. Arhaus' store count increased by 5 locations, or 6.25%, over the last 12 months to 85 total retail locations in the most recently reported quarter. It has had a new website since December 2021, which has increased traffic, sales conversion, and time on site. E-commerce revenue increased 43% YoY, with over 28 million website views.

Arhaus has recently made significant enhancements to its sales and delivery pace through various backend improvements, such as its distribution centres and technological upgrades. Notably, in 2022, the company invested in a large 800,000-square-foot distribution centre in Dallas and expanded its Ohio centre by an additional 200,000 square feet.

Looking into the future, Arhaus has increased its expectations for full-year 2023 net revenue, net income, and adjusted EBITDA. To further expand and grow, the company plans to open 5 to 7 new showrooms annually in the years to come. Additionally, the company has set a long-term goal of reaching 165 traditional showrooms, which will include the incorporation of 100 smaller design studios. The expansion of these showrooms and studios is a strategic and deliberate effort to broaden Arhaus' market presence and drive sustained revenue growth.

This is considering that the luxury furnishings market has a TAM of $100 billion in the USA and a CAGR of 6% until 2025. Arhaus has less than 2% of the market share. The market is very fragmented and competitive across approximately 22,000 stores in the USA. It competes against larger players with higher brand awareness, such as RH ( RH ) and Williams-Sonoma ( WSM ). While the company does not have economies of scale, it benefits from an extensive network of artisans and has yet to enter the international markets.

Financials

Arhaus delivered a solid third-quarter performance, beating analysts' revenue, adjusted EBITDA, and EPS expectations. Arhaus reported net revenue of $326 million in the third quarter of 2023, a 1.9% increase from the same period last year. The company also raised the midpoint of its full-year 2023 outlook for net revenue, net income, and adjusted EBITDA. As you can see below, the company's annualised revenue growth rate of 39.9% over the last four years (we compare to 2019 to normalise for COVID-19 impacts) was incredible as it added more brick-and-mortar locations and increased sales at existing, established stores. Gross margin as a percentage of net revenue decreased 250 basis points to 40%, primarily reflecting higher fixed showroom costs and higher product and delivery costs.

The net income for the third quarter of 2023 experienced a significant decline of 47%, down to $20 million. However, when considering the TTM, there is a noticeable upward trajectory, reaching $141 million. This positive trend over the longer period suggests a potential for sustained profitability and growth. It indicates a broader and more comprehensive view of the company's financial performance.

The company has reported a TTM levered free cash flow of $104.1 million, which is a significant improvement from the negative levered free cash flow reported in the previous period. This positive shift is a sign of the company's enhanced ability to generate cash from its operations while managing its debt obligations.

The balance sheet displays $236.93 million in total cash. However, the high total debt-to-equity ratio of 148.50% is a concern. While the current ratio of 1.46 covers short-term liabilities, the lower quick ratio of 0.62 suggests that a significant portion of current assets ($269 million) is tied up in less liquid inventory.

Valuation

With a market capitalisation of $1.69 billion, Arhaus is among the smaller players in the industry, but it has a strong balance sheet on hand and positive free cash flow over the last 12 months. This gives Arhaus the financial flexibility to invest in growth opportunities and enhance its competitive edge.

Considering Seeking Alpha's Quant valuation, Arhaus is trading at a forward P/E ratio of 12.93, lower than its industry peers RH , which has a forward P/E ratio of 38.56 and Williams-Sonoma with 13.72. Arhaus also has a more attractive price-to-sales ratio of 1.16. This is well below the industry average of 1.42 and suggests that the stock has room for upside. Arhaus is considered a strong buy by Wall Street analysts and is still trading below its average price target of $12.94, indicating upside potential. Moreover, the short interest in Arhaus has declined significantly from 23.86% in March to 7.31% in November, indicating that the bearish sentiment has eased and the market is becoming more optimistic about the company's prospects.

Risks

Investors should be aware of several risks associated with investing in Arhaus. Firstly, the company's stock price has exhibited significant fluctuations over the past year, with a high of $14.90 and a low of $6.81. Hence, investors should be prepared for the possibility of increased volatility and uncertainty in the market. Secondly, Arhaus operates in a highly competitive industry, with numerous online and offline rivals offering similar or alternative products and services. Some of these competitors may have more financial, marketing, and operational resources than Arhaus and may be able to adapt more quickly to changing consumer preferences and market conditions. Lastly, while Arhaus boasts of its American-made furniture, it also sources its products from manufacturers and artisans worldwide, exposing it to various risks such as transportation delays, labour disputes, natural disasters, trade restrictions, and currency fluctuations. Any disruption in the supply chain could negatively impact Arhaus' ability to deliver its products to customers on time, quality, and cost.

Final thoughts

The company's stock has surged by 38.30% since my previous article, approaching the $12.94 average price target with a 7.3% potential upside. Its 'directly sourced, often American' model, robust online presence, and brand distinctiveness provide a solid competitive edge. Expanding showrooms and digital enhancements have led to a 43% YoY e-commerce revenue surge. Financially, we can see TTM's top and bottom line results are upward trending, and the company has positive levered free cash flow that it can reinvest into the business for its growth strategy. Although cautious of the historical stock volatility and competitive market, I maintain a bullish stance on a company showing strength through its strategic growth plans and strong market positioning.

For further details see: