ARHS - Arhaus Improves Supply Chain Dynamics But Revenue Growth Will Slow

2023-07-28 16:26:27 ET

Summary

• Arhaus, Inc. is a designer and retailer of premium quality furniture products in the United States.
• The firm's forward top line revenue growth rate estimate is in the low single-digit percentage.
• While the U.S. economy appears reasonably solid with high employment, I'm Neutral [Hold] on Arhaus due to valuation and caution about macroeconomic trends.

A Quick Take On Arhaus

Arhaus, Inc. ( ARHS ) is an omnichannel retailer of premium quality home furnishings.

I previously wrote about Arhaus in November 2022 with a Hold outlook.

A potential upside catalyst to the stock could include stronger-than-expected consumer demand as employment remains robust.

However, I'm cautious about Arhaus, Inc. stock due to valuation coupled with my pessimism about the U.S. economy in the face of rising cost of capital conditions.

I'm therefore Neutral [Hold] on ARHS for the near term.

Arhaus Overview And Market

Boston Heights, Ohio-based Arhaus was founded to sell "heirloom quality, artisan-made furniture and decor" products via an omnichannel approach.

Management is headed by co-founder and CEO John Reed, who has been with the firm since its inception and had previously stepped out of the CEO role only to have to step back in when new CEO Adrian Mitchell resigned in 2019 after only one year on the job.

The company's primary offerings include:

• Furniture.

• Accessories.

• In-Home Design Services.

• Digital Tools.

The firm pursues an omnichannel business model, with over 85 retail stores and online direct-to-consumer website and ordering capabilities.

Management has said it intends to open "between five and seven new stores per year for the foreseeable future."

According to a 2021 market research report by Global Market Insights, the global market for furniture was an estimated $546 billion in 2020 and is expected to reach $785 billion by 2027.

This represents a forecast CAGR of 5.4% from 2021 to 2027.

The main drivers for this expected growth are continued growth in the development of new residential projects and "ongoing smart city developments."

Also, below is a chart showing the global furniture market at a glance:

The U.S. furniture market is highly fragmented, with over 23,000 retail furniture establishments.

The company competes with various national and regional retailers, department showrooms, mail-order catalogs, interior design trade showrooms and others.

Arhaus' Recent Financial Trends

• Total revenue by quarter has continued to rise impressively; Operating income by quarter has also risen year-over-year.

• Gross profit margin by quarter has trended higher YoY; Selling, G&A expenses as a percentage of total revenue by quarter have fallen in recent quarters.

• Earnings per share (Diluted) have produced the following results.

(All data in the above charts is GAAP).

In the past 12 months, ARHS's stock price has risen 109.9%, as the chart indicates below.

For the balance sheet , the firm ended the quarter with $144.5 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash used was $4.1 million, during which capital expenditures were a hefty $51.0 million. The company paid $5.2 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Arhaus

Below is a table of relevant capitalization and valuation figures for the company.

(Source - Seeking Alpha).

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm's projected growth and earnings.

Assuming generous DCF parameters, the firm's shares would be valued at approximately $10.98 versus the current price of $11.02, indicating they are potentially currently fully valued , with the given earnings, growth, and discount rate assumptions of the DCF.

Commentary On Arhaus

In its last earnings call ( Source - Seeking Alpha ), covering Q1 2023's results , management highlighted its continued focus on investing in physical showrooms, with plans on track to open 12 new stores in 2023.

The company's supply chain conditions appeared good, and management began implementing a new warehouse management system, 'which will enable us to move product through the supply chain more efficiently.'

Total revenue for Q1 2023 rose by 23.7% year-over-year, while gross profit margin also increased, by 2.4%.

Selling, G&A expenses as a percentage of revenue fell 3.2% YoY, a positive development, and operating income almost doubled, rising 98.7%.

The company's financial position is strong, with ample liquidity and no debt; it generated a small amount of negative free cash flow in the last twelve months.

Looking ahead, consensus revenue estimates for 2023 suggest topline growth of only 2.5%, and management reaffirmed forward guidance.

If achieved, this would represent a sharp decline in revenue growth versus 2022's growth rate of 54% over 2021, indicating a substantial flattening in its future growth trajectory.

From management's most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below.

I'm most interested in the frequency of potentially negative terms, so management or analyst questions cited "Recession" once, "Uncertain" two times, "Macro" two times and "Drop" two times.

Analysts questioned company leadership about new products and CEO Reed stated that customer response to new products has been "phenomenal" as the firm continues to "expand into more SKUs, more sizes, more categories of similar looks" of some products.

Regarding valuation, my discounted cash flow calculation suggests the stock may be fully valued at its current level.

A potential upside catalyst to the stock could include stronger-than-expected consumer demand as employment remains robust.

However, I'm more cautious about the stock due to valuation and to my pessimism about the U.S. economy in the face of rising cost of capital conditions.

I'm therefore Neutral [Hold] on Arhaus, Inc. for the near term.

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