After soft guidance in March, Arhaus (ARHS, Financial) stock has dropped 39%, putting it below the company's IPO price. Despite worries over consumer debt and spending or the fear of a lackluster commercial real estate market spilling over to residential properties, I believe Arhaus should be able to weather the storm to produce shareholder value in the long-term, making it undervalued at current levels.
About Arhaus
Arhaus is an Ohio-based company founded in 1986 by John Reed. It is a luxury home furniture retailer that markets towards affluent customers. 65.8% of Americans own a home with nearly roughly 6 million homes being valued at $1 million or higher as of February 2023, according to data from Redfin. That's a pretty sizable market for Arhaus to address. Plus, with almost $1.5 trillion in commercial real estate debt coming due by the end of 2025, many retail tenants like Arhaus are in a good position to negotiate, locking in some of the largest costs to ensure growth meets management's expectations.
Since its founding, it has grown to operate 81 retail stores across the United States, each producing around $15 million in annual sales as of the most recent earnings numbers. Arhaus specializes in high-quality furniture, home decor and accessories, all designed to create a warm, inviting and sustainable living space. The idea behind the company was that “furniture and décor should be sustainably sourced, lovingly made and built to last.”
The name "Arhaus" is derived from a combination of the Danish city "Aarhus" and the word "house," reflecting the company's focus on creating unique and comfortable living spaces - plus the obvious play on words with “our house." The company went public in late2021 and its stock is down 35% since then, which is not unusual for a recent IPO.
When the company had its IPO, it outlined a path to 165 stores, aiming to open five to seven each year. I believe the trouble in commercial real estate should be helpful to that pursuit. The higher store count will likely coincide with higher revenue numbers. If it stays on track, revenue could surpass $3 billion by the end of the decade. At the same margins, that would put earnings in the $300 million range.
Competitors
Arhaus somewhat competes with all furniture sellers, but in particular, it targets a very similar customer base to Restoration Hardware (RH, Financial), though in my personal experience I think Arhaus has more unique pieces. That said, affluent shoppers for home furnishings could easily have pieces from each of these stores.
Admittedly, Arhaus does not have the brand value RH does, but I believe it is catching up fast. Founded just a few yers after RH, Arhaus has been recognized for its design excellence, including winning multiple awards from the American Society of Interior Designers (ASID). The company has also received numerous accolades for its commitment to sustainability, including being named one of the "World's Most Ethical Companies" by Ethisphere Institute for six consecutive years.
RH is a favorite among guru investors. Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A)(BRK.B) owns more than 2.3 million shares as of its 13F filing for the fourth quarter of 2022. Both Dan Sundheim’s D1 Capital Partners and Steve Mandel (Trades, Portfolio)’s Lone Pine Capital owns more than 1.7 million shares. These three firms collectively control 27% of the shares outstanding.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
The good thing about the furniture business is that inventory can sit for longer because styles change so infrequently. Arhaus collaborates with global artisans in crafting stunning, heirloom-quality items that can be cherished and utilized for generations. This also means the same piece could sell today or 10 years from now. These talented artisans create a global network from rug weavers in India and upholstery workshops in North Carolina to families of master woodworkers in Italy and Mexico. These partnerships can span generations, thus the company isn’t forced to rely on single source producers for its customers orders.
From 2019 to 2022, Arhaus has more than doubled sales from $494 million to over $1.2 billion with net income going from $14 million to $136.6 million in the last 12 months. At RH, sales grew from $2.5 billion to $3.6 billion and net income also bounded upward from $135 million to $528 million. RH is by far the larger business; however, since 2012 it has struggled to produce consistent growth in retained earnings and has taken on more than $2.4 billion in long-term debt ($3.75 billion total debt) to build its brand, an amount that may come back to bite the company later on. Arhaus on the other hand has less than $400 million in total debt and a cash position approaching $150 million. Take out capital leases and the company has a positive net current asset position.
More importantly, Arhaus is on par with RH in profitability metrics with close to 42% gross margins, 11% net profit margin and a nearly 16% return on assets. The company has a forward price-earnings ratio of just 10 and a forward price-sales ratio of 1 based on its estimates.
Quarterly results
Arhaus reported solid financial numbers for the fourth quarter and full year of 2022, with significant growth in net revenue and net income for both the quarter and the fiscal year. Net revenue for the quarter was up 49.5% compared to the prior year, driven by better distribution and supply chain infrastructure. Both should be good long-term as well. For the year, revenue was up 54% to $1.2 billion thanks to higher demand across both digital commerce and showroom sales with faster delivery of backlog orders. These factors pushed net income up 270% year over year.
A big reason the stock is a bargain right now is likely thanks to the soft guidance for the upcoming year. The retailer expects 2023 revenue of $1.23 billion to $1.30 billion versus the $1.37 billion analysts wanted, and comparable sales growth of -4% to +1% with full-year adjusted Ebitda of $180 million to $195 million versus the $205 million analyst consensus. Again, taking a step back and looking at these numbers without historical context, they’d be amazing at a $1.1 billion valuation.
Conclusion
While Arhaus doesn’t have the flashy galleries like RH to showcase its luxury goods, it also doesn’t carry with it the same financial burden and can just focus on what matters - delivering value to customers and opening new stores at a profit. That's why I like Arhaus' business model and believe it is a great value at current levels.
