ARHS - Arhaus: Investing In Showrooms Technology And Increased Distribution Capacity

2023-03-21 04:51:19 ET

Summary

• Arhaus is gaining market share in the premium home furnishings industry through an omnichannel sales strategy, generating revenue through new products, showroom expansions, and increased distribution capacity.
• Arhaus increased revenue YoY by 54.2% to $1,229 million, has a strong balance sheet, 82 showrooms and adding, and surpassed EPS expectations by $0.14 to reach $0.34.
• Cautious of high short interest, management's conservative outlook for 2023 due to lower backlog and increased concern about the macroeconomic environment.

Arhaus, Inc. ( ARHS ) is a small-cap stock with a market cap of $1.308 billion focused on luxury home furnishings. IPOing the year-end of 2021, the stock enjoyed a relatively positive sentiment until its Q4 2022 earnings call, in which management forecasted underwhelming results for 2023.

In 2022 luxury demand remained strong amidst consumer weakness, and ARHS beat earnings expectations for four consecutive quarters. Most recently, the company reported an EPS of $0.34 , a surprise of $0.14. We should be cautious of management's weak forecast for 2023 due to a decrease in backlog and uncertainty regarding the macroeconomic environmental impact on the business. However, over the long term, I believe there is a lot more upside potential as the company has dramatically increased its distribution footprint, has an ambitious annual store growth plan and has significantly increased its brand value with an impressive online presence of over one million social media followers. Therefore, investors may want to take a bullish stance on this stock.

Company overview

ARHS is a retailer focused on premium home furnishings and decoration. Although it only recently IPOd, the company dates back to 1986, and the same management team have led the company with John Reed , founder and CEO, at the head. Their typical customers are high-end consumers with plenty of money to spend and less sensitive to the economic downturn trend. The company provides many artisan-focused products obtained directly through 400 plus vendors and in-house production, sold through an omnichannel experience via showrooms, catalogues, their website and social media presence. ARHS has invested significantly in its technologies and in-store experiences.

ARHS 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. Furthermore, its Instagram account has over 1.2 million followers.

On the backend, its distribution centre and technological advancements have played a role in the speed at which offerings have been sold and delivered. In 2022 ARHS invested in an 800,000-square-foot distribution centre in Dallas and expanded its distribution centre in Ohio by 200,000 square feet.

In 2015 ARHS acquired one of its most prominent vendors, allowing it to expand production and double in-house capacity. This has also led to improved operational margins with more control over product expenses. It has over 400 vendors from which it sources directly, with 60% of the net revenue generated by its ten largest vendors.

Growth potential

ARHS sells offline through showrooms and outlet stores. It has 81 showrooms, which include three outlet stores across 29 US states. Showrooms quickly bring in returns, with a target payback within two years . For 2023 the company expects to add 12 new showrooms and expand or renovate five existing showrooms. ARHS forecasts annually opening 5 to 7 new showrooms for the following years. It also plans to add 100 smaller design studios to a long-term goal of 165 traditional showrooms.

The luxury furnishings market has a TAM of $100 billion in the USA and a CAGR of 6% until 2025. ARHS 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 more significant players with higher brand awareness, such as Restoration Hardware ( RH ) and Williams-Sonoma ( WSM ).

Financials and valuation

ARHS released its latest earnings report with solid results, and we can see attractive upward trending results since 2019 across its revenue, gross margin improvement and adjusted EBITDA. Its net revenue increased 54.2% YoY to $1,229 million. The gross profit margin has increased to 43%, the adjusted net income increased by 71% YoY to $142 million, and the adjusted EBITDA increased by 81.1% to $223 million.

Results were driven by growing demand and higher revenue, quicker delivery of backlog due to increased distribution capacity over the last year in North Carolina, Dallas and Ohio, and improvement in product lead times. Results were partially offset by increased costs related to the higher demand impacting freight, rent expenses, credit card fees and additional production costs. The gross profit margin has improved yearly from 35.59% in FY2019 to 48.64% in FY2022.

The net income has been upward trending over the last four years.

If we look at the balance sheet, ARHS reported $145 million in cash and cash equivalents with no long-term debt. Its net merchandise inventory was $286 million, which was a YoY increase of $78 million related to responding to consumer demand. Net expenditure was roughly $36 million for the year, and the company expects capital expenditure for FY2023 to range between $75 million and $85 million.

We can see that the short interest is very high at 23.86%, indicating that investors are bearish on the stock since announcing a weak forecast for FY2023 at revenue of $1,240 million to $1,300 million, Comparable growth between negative 4% and 1% and adjusted EBITDA between $180 million to $195 million. However, if we compare ARHS's price return to its larger peers, RH and WSM, we can see that the stock has performed well during this challenging year with a favourable price return of 12.25%. According to Tipranks, the stock has a price target of $13.08 and is rated as a Strong Buy.

Considering Seeking Alpha's Quant valuation, we can see that ARHS FWD price-to-earnings ratio is 11.24, lower than its direct competitor RH but higher than WSM. Its price-to-sales ratio is under one at a value of 0.96, indicating that the stock may still be undervalued as investors pay less than one dollar for every dollar generated.

Risks

ARHS delivered a solid financial year. However, it is still in a significant growth phase, investing in new stores, and results are likely to fluctuate before we can better understand an accurate growth rate. Furthermore, the macroeconomic concerns could impact the performance as we see a slowdown in the luxury home-building business. The market is bearish on the stock with a very high short interest of over 20%. ARHS remains a minor player in a very competitive and fragmented industry. RH may need to offer discounts or promotions to stay competitive, which could hurt its margins and overall performance.

Final thoughts

ARHS closed off the year with record financials; however, the management team have painted a cautious picture going into FY 2023. The stock has rewarded investors with one-year returns of 12.25% and has a FWD price-to-earnings ratio of 11.25, which is lower than fellow luxury peer RH and below the consumer discretionary sector median . While the company had a solid financial year in 2022, its outlook for 2023 due to strong near-term headwinds is underwhelming. Furthermore, we can see a very high short interest of 23.96%, which indicates pessimism towards the stock. I do not recommend this stock if you are looking for short-term returns. However, the company has and will continue to invest in the business's long-term growth through storefronts that have historically proven to cover investment costs within two years. We also see a significant improvement in brand awareness, increased social media attention and a huge untapped TAM of $100 billion, of which ARHS currently holds less than 2% market share. Therefore investors may want to take a bullish stance on ARHS stock.

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