2023-05-12 01:03:07 ET
Summary
- Reed took the company to new heights by conducting its IPO in 2021 after 35 years of steady growth.
- The company aimed to expand its store count to 165 by 2038, with a planned pace of 5-7 store openings per year. It grew its revenue by 54% and its operating profits by 42% in 2022.
- Despite the company doing well in 2022, 23% of its shares were shorted.
Aiming Higher
Perhaps being 66 years old no longer qualifies as old in the realm of business. John Reed, along with his father, established Arhaus, Inc. (ARHS), in Cleveland, Ohio, back in 1986. After 35 years of steady growth, Reed has now embarked on taking the company to new heights by conducting its IPO in 2021. Evidently, there is an underlying motivation propelling both this individual and the company.
The company reported its Q1 earnings on May 4. ARHS stock has gone up 15% since then but is still down 8.3% YTD. The company reported 23% growth in revenues and adjusted EBITDA growth of 75%.
Arhaus was confident in the promising future of the luxury furniture market.
According to FMI :
The global luxury furniture market is predicted to register a CAGR of 5.6% over the forecast period. The industry's size is anticipated to increase from US$ 22.6 billion in 2023 to US$ 38.97 billion by 2033.
Arhaus aimed to grow its store count to 165 from the current 82 by 2038, with a planned pace of 5-7 store openings per year. Having opened nine stores in 2022, they now operate in 29 U.S. states. Additionally, Arhaus identified an opportunity to boost its eCommerce revenues, as only 17% of its net revenues came from online sales, which is lower than its industry counterparts.
However, after a great year for Arhaus, the company seemed to hit a speed bump. In its Q4 2022 as well as its Q1 2023 reports, the company reaffirmed its outlook for 2023 with 0-5.8% revenue growth, -4%-1% comparable growth, and a potential decline in its EBITDA margin. Regardless of the macro concerns, the company decided to make another push in the second half of 2023 to open 12 new showrooms.
We're not completely certain if this is the best decision because even Freeman Spogli , its private equity partner with a mandate to invest up to $750 million in transactions, chose to sell its shares when the company went public in 2021.
Brand awareness and product quality are important factors for luxury furniture companies. According to the company's data below, its brand awareness is still below that of its peers.
Brand awareness comparison (ARHS)
Arhaus has a vision to enhance its brand awareness by expanding its physical retail presence. The company also believes that its physical store can increase its revenues as its customers tend to make more substantial purchases when assisted by designers.
Clients that engage with our in-home designer services program exhibit a significantly higher repurchase rate, with approximately 40% of those clients making five or more purchases throughout their client lifetime.
Short staff and low NPS score
However, it is worth noting that only 65 out of their 81 showrooms currently have designers available. As of December 2022, Arhaus employed 870 individuals across its showrooms, averaging around 11 employees per store. This falls significantly short of the employee-to-store ratio of 25.8 observed at RH (RH) and 22.8 at William Sonoma ( WSM ). In the high-end furniture industry, exceptional service plays a crucial role. RH has emphasized the intense competition for skilled employees, particularly within the retail and hospitality sectors. The aforementioned figures raise concerns that Arhaus might be expanding at a pace that outstrips the growth rate of in-house designers and staff, potentially leading to a decline in service quality. This hypothesis is further supported by a low Net Promoter Score [NPS] compared to industry peers, accompanied by numerous customer complaints about service-related issues.
NPS score (Comparably)
NPS score for RH and WSM (Comparably)
Additionally, according to the company's statement, its dependence on McCreary Modern, its main upholstery provider, has decreased noticeably. In 2022, only 15% of purchases came from McCreary Modern, down from 45% in 2020. It is yet unclear whether this large move will have a negative impact on the quality of their products, even though this reduction may lessen concentration risks.
For example, we purchased products representing approximately 45% of upholstery net revenue and approximately 25% of our total net revenue, in 2020 from McCreary Modern, Inc.
Competing with Giants
However, despite its aggressive move, the company deserves recognition for its impressive efforts, evident in the significant rise in gross margin from 39.9% in 2020 to 42.7% in 2022. When compared to its industry peers, Arhaus proves to be equally competitive in terms of margin profile.
Margins comparison (Seeking Alpha)
In fact, the company experienced exceptional growth in 2022, outpacing furniture giants RH and WSM. It grew its revenue by 54% and its operating profits by 42% in 2022.
Based on Comparably's assessments , the company received a 60% positive evaluation for customer loyalty. We also received feedback from industry experts, who reaffirmed its exceptional quality.
Valuation
Valuation multiple (Seeking Alpha)
Growth comparison (Seeking Alpha)
Despite the company's success in 2022, Seeking Alpha reported that 23% of its shares were shorted. All three stocks—Arhaus, RH, and WSM—traded below their forward P/E ratios, indicating that the market anticipates a fall in the luxury furniture sector in 2023. The company's flat revenue guidance and decreased margin outlook for 2023 suggest a challenging second half ahead.
In the long term, we still see upside growth potential for the company, considering it is only half the size of RH and one-sixth the size of West Elm. However, we believe that maintaining its rapid speed in 2022 may prove difficult due to its weaker brand awareness compared to competitors and probable delays in its aggressive expansion ambitions brought on by potential macroeconomic slowdowns and staffing shortages. Rapid growth while facing a staff shortage could have a negative impact on the company's reputation and ability to provide services.
Even if the luxury furniture industry bounces back faster than anticipated due to subdued inflation, we prefer owning WSM and RH due to their superior service capabilities (higher staff-to-store ratios) and higher brand awareness. Therefore, we recommend a hold rating for the stock based on an assessment of the risks and rewards associated with industry growth prospects and the company's fundamentals.
Summary
The company had experienced a dramatic change after its IPO. It became more diversified in its concentration on single supplies and doubled its revenues in two years. We believe the company has good quality products and a loyal customer base, and that the luxury furniture industry is promising in the long term. However, we prefer the management grow the company at a steady rate to prioritize team building over geographical expansion. Considering its stock valuation and fundamentals, we give it a "hold" rating.
For further details see:
Arhaus: Chasing The Goliath