2001 Review: Restoration Hardware Shakes Off the Dust

Former down-and-out Internet outfits aren't the only stocks to do surprisingly well this year. A year after nearly landing on the junk heap, Restoration Hardware RSTO is again showing some polish.

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Restoration Hardware Shakes Off the Dust

Upscale home-decor chains have surged since the Sept. 11 terrorist attacks, as recession-struck Americans refocus their spending on home and hearth. But none has risen as much as Restoration Hardware, whose shares are up nearly 700%. In addition to benefiting from the cocooning trend, Restoration Hardware has struck a chord with its old-school record players and retro cocktail shakers.

Now the stock, which traded for pocket change at this time a year ago, is making believers out of investors. Restoration Hardware still loses money, but it plans to change that, courtesy of a CEO who has turned around yuppie retailers before. If the company can show some improved financial results, there's no reason this rally can't keep going, bulls say.

"The whole thing is going to be a total transformation," says Daniel Schwarzwalder, managing director at Buckingham Capital, which began buying shares six months ago and now owns more than 250,000 shares in the Corte Madera, Calif.-based company.

Cutting the Clutter

Schwarzwalder began buying shares in the spring just as the company hired Gary Friedman away from rival Pottery Barn, where he was well-regarded for building that brand. "We were a believer in the new management," Schwarzwalder says.

Friedman's plan for Restoration's restoration hinges on eliminating clutter while expanding its offerings. The company has slashed prices on some 3,000 weak-selling items and has closed several underperforming stores, bringing its total to 104. The plan for next year is to open a store in Durham, N.C., and close a "handful" of others, according to marketing director David Glassman.

Come Back Soon Gross margins on the wane at Restoration

*Estimates. Source: Stephens

Restoration also plans to launch a private-label linens business in the spring, hoping to expand textile sales to 15% of revenue from 4% now. The company believes the new line will boost margins while easing the logistical squeeze that eroded the company's furniture delivery business the first time around. Noting the role of poor inventory management in its steep decline through 1999 and 2000, the company says it has planned better this time around and doesn't expect deliveries to go awry or merchandise to arrive damaged anymore.

If a Tree Fell

If Restoration Hardware does continue its winning streak, it will be because individual investors like the story. The stock isn't widely followed on Wall Street; only one analyst, Richard Nelson, of Little Rock, Ark.-based Stephens, officially covers the stock, according to Thomson Financial/First Call. Moreover, Restoration hasn't offered specific financial guidance, saying only that it hopes to grow into a $1 billion-a-year business, Nelson says. Revenue is expected to be $346 million this year.

Swing, Batter Earnings stuck in the red at Restoration

*Estimates. Source: Stephens

"It is a transition year for us," says Cindy Love, the company's vice president of finance. Explaining why the company hasn't offered more detailed guidance, she says, "We will probably start that practice next year when we are a little bit more through the strategy."

That kind of data could be useful because Restoration's rebound is anything but a sure thing right now. The last year the company made money was in 1998, when it earned 30 cents a share. It lost 18 cents a share in both 1999 and 2000, and its loss this year is expected to be 51 cents a share. On the sales front, the company, which doesn't report monthly data like most retailers, has also struggled: It recently reported a steep 8.8% third-quarter drop, marking the fifth-straight quarter of declining comparable-store sales ; the last time they rose was in the second quarter of 2000, when they nudged up 0.8%.

Nelson expects the company to swing to the black in 2002, earning 25 cents a share. Still, he's hesitant to recommend the shares, saying he'd like "to see evidence that sales and profitability are beginning to strengthen" first. (He has a neutral rating on the stock, and his firm doesn't have a banking relationship with the company.)

But vintage record players are "white hot," says Glassman -- making them the company's top-selling holiday item ever. (The company opened its first store in 1980, out of the home of founder Stephen Gordon; it went public in 1998.) Its Super Chill cocktail shaker has also been a hit, and its collection of small instruments called Family Band has sold out.

For investors like Buckingham's Schwarzwalder, that is good enough: "The bottom line is you have to have what the customer wants."