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High End Retailers Show Signs of an Economic Slowdown

High End Retailers Show Signs of an Economic Slowdown

RH stock (NYSE: RH) fell sharply after lowering its guidance for the current year.

RH daily chart

RH, formerly Restoration Hardware Holdings, Inc., is a retailer in the home furnishings marketplace. It offers merchandise assortments across a range of categories, including furniture, lighting, textiles, bathware, decor, outdoor and garden, tableware, and child and teen furnishings.

The company classifies its sales into furniture and non-furniture product lines. The Furniture category includes both indoor and outdoor furniture. The non-furniture category includes lighting, textiles, fittings, fixtures, surfaces, accessories and home decor.

RH also owns a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name ‘Waterworks’.

RH focuses on luxury homes and that segment of the market is expected to slow this year. That forced management to lower its outlook even though the company had a strong quarter.

Quarterly earnings Beat Expectations

Barron’s reported that RH earned $3 a share on revenue of $671 million in the most recent quarter. Analysts were looking for EPS of $2.86 on revenue of $686.44 million.

“The company noted that its performance often dovetails with that of the market, and thus said that the revenue shortfall was due to the December selloff.

For the current year, RH lowered guidance, and now sees EPS of $8.41 to $9.08, down from a prior range of $9.30 to $10.70, and compared with the $9.98 consensus estimate.

It expects revenue of $2.585 billion to $2.635 billion, down from its prior forecast of $2.72 billion to $2.82 billion, while the consensus calls for $2.75 billion.

The company said ongoing weakness in its core business on the heels of fourth-quarter market volatility, along with negative trends at the high end of the housing market were largely to blame.

Still, it reiterated confidence in its long-term financial targets, which include net revenue growth of 8% to 12% and adjusted earnings growth of 15% to 20%, annually.

“We continue to see a clear path to $4 to $5 billion in North American revenues, and an international opportunity that could lead to RH becoming a $7 to $10 billion global brand.”

Analysts responded quickly according to Barron’s,

“Deutsche Bank ’s Mike Baker lowered his rating on RH to Hold from Buy and cut his price target to $124 from $185.

“While we continue to believe in the long-term prospects for RH and acknowledge that it is one of the few retailers growing sales, margins, profit dollars and earnings, we think the market volatility means now is not the time to continue to own the stock,” Baker wrote.

“Estimates are coming down as RH’s high-end, highly discretionary product falls victim to signs of a slowing economy and stock market gyrations and weakness in high-end housing trends.” That makes it harder to predict top- and bottom-line results for the company, and he believes that consensus estimates have further to fall.

Loop Capital’s Anthony Chukumba has a Buy rating, as he believes that RH is doing well in focusing on the long run, but sliced his price target by $60, to $140. Stifel’s John Baugh kept a Buy rating on RH, citing his confidence in the brand and its attractive valuation, but cut $35 from his price target, to $145.

Yet as Credit Suisse ’s Seth Sigman writes, it’s not just RH’s problem.

Sigman, who’s long been cautious on home retailers, argues that the most recent commentary from the space points to a widening gap in the industry, with a number of full-price players seeing a slowdown in sales that hasn’t dented more value-oriented stores yet.”

This could be bearish for RH, especially after the plunge pushed the stock below important support levels on the weekly chart.

RH weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in RH

For RH, we could sell an April 18 $105 call for about $3.65 and buy an April 18 $110 call for about $1.75. This trade generates a credit of $1.90, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $190. The credit received when the trade is opened, $190 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $310. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($190).

This trade offers a potential return of about 61% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if RH is below $105 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $210 for this trade in RH.