Is This Home Improvement Stock Presenting a Great Post-Earning's Opportunity?

Restoration Hardware announced Q2 earnings on September 10, and increased guidance in just about every notable metric. But after a 125% gain in 2013, is this stock presenting value, and is it still a good buy?

How's it measure up?
On July 25, I wrote an article entitled 'Which Stock Is Best in the Home Improvement Space ?," which clearly showed the level of value in shares of Restoration Hardware compared to Lumber Liquidators .

Both companies operate in the home improvement space but have different operational approaches. Restoration offers products for high-end consumers while Lumber Liquidators is primarily a floor company. Yet, due to stock performance, and industry, both are often compared.


Since my first article, Lumber Liquidators and Restoration Hardware have posted stock gains of 15%, and after Restoration's recent quarter, the value is even more apparent. Take a look at a few key metrics that were used in the previous article, but with updated "full-year guidance" from the company's Q2 report .

 

Lumber Liquidators

Restoration Hardware

Revenue/ year-over-year Growth

$951 million/ 17 %

$1.57 billion/ 32%

Comparable Growth Guidance

High-Single/Low-Double Digits

26%

EPS Guidance

$2.52

$1.68

Market Cap

$2.96 billion

$2.77 billion

Price to 2013 Expected Sales

3.11

1.76

Forward P/E Ratio (2013 full-year)

42.64

43.4

Lumber Liquidators and Restoration Hardware are fast-growing companies, but clearly, Restoration is growing faster and is priced cheaper.

With 32% expected top-line growth, and a price to 2013 sales of only 1.76, the comparison really ends. In theory, two companies in the same industry share a similar valuation if growth is comparable. When one company has greater growth, the market awards a higher valuation compared to the fundamentals, as expectations become higher.

In the case of Lumber Liquidators and Restoration Hardware, this is simply not the case. Restoration should be awarded the higher valuation, and has proven quarter-after-quarter that its growth is nowhere near ending. In fact, Restoration has increased guidance in each quarter since becoming public last year, and in an economy with somewhat stagnant growth, Restoration is a rare performer.

Irrational behavior means what?
Surprisingly, after Restoration Hardware's impressive Q2, where revenue grew 30% year over year, shares fell 4% in afterhours to $73. This performance came despite a quarter where comparable sales grew 26%, meaning the majority of revenue growth came from existing stores. In the quarter, Chairman and Co-CEO Gary Friedman conveniently notes that Restoration's comparable growth from 2011-2013 has been 17%, 31% and now 26%, thus showing continued strength.

Now, it is very difficult to determine why Restoration's stock fell lower, but looking ahead, it doesn't really matter. In the long run, if a company does good, its stock usually follows, thus we can label Restoration's current performance as irrational behavior in the market.

In many ways, it reminds me of Harley Davidson back in October 2011. The company had reported earnings , and blew away top and bottom-line estimates with worldwide sales growth of 5.1% over the previous year. Yet, the stock fell 9%. In the process, analysts desperately sought a reason for the madness; they found one in gross margin guidance.

In that particular Q3 report, analysts had expected gross margin guidance of 34.5%, but Harley Davidson estimated its gross margin at 34%. Thus, analysts blamed that 0.5% difference for a 9% stock loss. Clearly, it didn't make sense, and Harley's stock has went on to post gains over 60% since that October quarter, about double the S&P.

In my opinion, this is a good example of seeing a good quarter, acting on the fundamentals, and then being rewarded despite the market's initial insanity.

Final thoughts
In the case of Restoration Hardware, a similar outcome is likely. Right now, the immediate stock reaction is being blamed on a net loss of $0.46 a share, as analysts expected a profit of $0.43 a share. However, that loss only occurred because of a one-time charge related to stock-based compensation and costs associated with a follow-on offering.

The adjusted EPS was $0.49, beating estimates, as net income growth of 62% outpaced revenue growth, indicating a rise in operating margins. Thus, those excuses will likely die down, and based on fundamentals, we will likely see a Harley Davidson-like effect - that is if the stock actually stays lower.

 

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The article Is This Home Improvement Stock Presenting a Great Post-Earning's Opportunity? originally appeared on Fool.com.

Brian Nichols is long RH. The Motley Fool recommends Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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