Event: Restoration Hardware (RH) reports Thursday night after the close. The options market is implying about a 8% one day move in either direction (based on Apr implied volatility at 46 and May implied volatility at 39).
Price Action / Technicals: RH has tripled in the past 2 years, rising from around $30 to above $90 in a very steady fashion:
The stock broke out to a new high above $95 on the December earnings report, and has been relatively flat ever since. However, the stock has held above the rising 200 day ma, which is now around $85. The stock’s all-time high is $100.66.
Fundamentals: RH has short interest of over 30%, and is a highly contested story. While sales and gross profit have grown at a rapid 20-30% annual pace over the past 3 years, shorts point to the perpetually growing inventory as a sign of juiced earnings with negative cash flow. One analyst probed CEO Gary Friedman about the inventory issue on the December earnings call, and Friedman answered as follows:
You can think about inventory turns and inventory optimization in a real vertical sense versus a horizontal model which is the model we’ve had, you know, to kind of get to where we are today as we’ve been trapped in these legacy stores, is, from a cash and return on investment point of view, because we’ve got a big capital workload, and an under-optimized investment in inventory, when we start growing vertically and we start using square footage, the model shifts. And then you start to get a model that will be highly optimized. And I would anticipate in the future that the inventory turns and the optimization to this model from, not just an inventory point of view but a cost point of view, will look very different in the future, which is reflected in the long-term potential of the company as Karen laid out in her presentation.
In other words, Friedman is explaining that the increase in inventories is simply a result of a larger, growing business, and that will normalize at some point in the future. The shorts clearly don’t believe him, while the longs do.
As a result, it’s tough to say whether the 52x P/E and the $3.7 billion market cap is fair value or not.
Volatility SnapShot: Implied and realized volatility in RH have gradually trended lower over the past 2 years. That’s to be expected as the size of the company has increased, and investors have become more comfortable with the fundamental trends:
RH realized volatility over the past 6 months has averaged around 35. In that context, 30 day implied volatility around 46 looks expensive going forward, indicating that options traders are expecting a big move (8-9%) on earnings.
Hypothetical Trades: Here are a few trade ideas into the print depending on your directional view:
(Note that they are all butterflies given the high level of implied volatility relative to realized volatility over the past 6 months, so be careful with bid/offer if you look to execute these trades.)
Bullish: Apr 90/100/110 call fly for $3.20
This structure targets the all time highs with an in-the-money fly that reduces premium risk as much as possible.
Neutral: Apr 85/95/105 call fly for $2.80
This is playing for a range bound stock with a decent payout of the stock is unchanged to slightly higher following the event.
Bearish: Apr 90/80/70 put fly for $1.75
This structure looks for a possible break of the rising 200 day moving average with a defined risk trade. If you’re looking for pure protection, you can buy the Apr 90/80 put spread for around $2.40
We are not trading the name as we have no strong view in any direction.