Company insiders, such as managers and executives, often sell stock in their companies to buy houses, lock in profits, or pay taxes. On occasion, insiders sell stock when they see a secular slowdown in their businesses.
stock with their hard-earned money for primarily one reason: They believe their stock is undervalued in the marketplace and expect higher prices.
Based on this premise, we believe the handful of insider buys at high-end housewares retailer
( RSTO) could be a precursor to share-price appreciation in the coming 12 months. Shares closed Tuesday at $6.30, but we aren't taking any action for the Stocks Under $10 model portfolio just yet as we want to see evidence that the insiders' optimism translates into earnings growth.
Restoration Hardware is a familiar company to us. We first initiated a position in June 2004, and continued to trade the stock throughout 2004 and into 2005. Over this time, our returns ranged from a loss of 31% in late 2004 to a gain of 15% in April 2005, when we closed the position. (Overall, our total return for the position was a loss of 9.7%.) Shares were trading at $6.20 when we exited the position.
We sold the stock from the model portfolio based on our belief that inventories had built too aggressively ahead of spring, and on the expectations that higher interest rates may crimp the consumer's ability to make big-ticket purchases. The stock price has remained largely unchanged since, though the stock did briefly spike higher last summer.
According to data compiled on Nasdaq.com, Restoration Hardware insiders have been active. Over the past year, there have been a total of 25 insider trades. Only six of the 25 trades have been sells, while a confidence-inducing 19 of the transactions have been buys. During the last three months there have been two insider trades, both of them buys.
Glenn Krevlin, a director on the company's board, has been the most active trader of Restoration's stock. As of December, Krevlin's most recent trade date, he held through Glenhill Advisors LLC -- of which Krevlin is the managing member -- 3.443 million Restoration Hardware shares, or 9% of the company's total. This is up from the 1.668 million shares Krevlin held in June 2005 when he began his buying spree. Krevlin is a managing member of Krevlin Advisors, an investment management firm, and also a member of Restoration's audit committee. Members of the audit committee are acutely attuned to the financial workings of a company.
Other buys of interest include Chairman and CEO Gary Friedman's 628,488 shares, via the conversion of a convertible preferred security last July, which took his stake up to 2.449 million shares, or 5% of the company's total market value. Friedman spent 13 years with industry leader
, and his sizable stake in Restoration Hardware speaks strongly about his conviction in Restoration's future.
Of course, insider buys by top executives and board members aren't enough to convince us to consider recommending a stock. A brief history of Restoration Hardware reveals a company that flirted with bankruptcy before the hiring of Friedman as CEO in 2001, and reinforces our guarded stance at this juncture.
With that in mind, we remain cautious about the company's long-term prospects as consistent growth and profitability are themes that have been hard to come by for Restoration Hardware over the past two years. Restoration sales rose a rather anemic 11% in fiscal 2005 to $581 million, while competitor Williams-Sonoma, which is much larger, managed to deliver 12.8% revenue growth. Restoration Hardware's fiscal fourth-quarter earnings results were not awe-inspiring, and underscore years of underperformance in the high-end retail category.
For the quarter, Restoration had earnings per share of 22 cents and revenue of $581 million, in line with Wall Street estimates. It is worth noting that the company had previously lowered its financial forecast for the quarter, so the quarter was widely expected to be in line with its prior expectations and analyst assumptions.
However, a glimpse at the company's balance sheet and management's first-quarter guidance paint a picture of bullish insider sentiment about the company's future.
Like most retailers, Restoration's balance sheet is low on cash and high on inventory. The company finished the January-ended quarter with just $2 million in cash, and $158 million in inventory. Inventory was up about $14 million from year-ago levels, though this is not alarming, as the days of inventory (which measures how many days it will take for the company to sell its inventory) is up only nine days to 125 days. In other words, sales growth is outpacing the increase in the number of days it takes to clear out inventory, so we are not overly concerned that the company will be forced to discount its seasonal merchandise.
Also, the company's revenue guidance for fiscal first-quarter growth of 15% to 18% from year-ago levels is an acceleration from the 10.8% year-over-year top-line growth the company turned in its fiscal fourth quarter. The first-quarter revenue guidance caught Wall Street by surprise, as most analysts were looking for revenue gains to be closer to 10% for the fiscal first quarter. The company also said it expects full-year revenue to grow 18% to 22% from year-ago levels, which would mark a solid inflection point for Restoration's top line.
Restoration will report first-quarter earnings results in late May, and we will be focused on whether management was able to work down the company's inventory balance with minimal discounting. Should the quarter match expectations and the company provide an upbeat outlook for future quarters, we could be persuaded to take a small position for the model portfolio.
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William Gabrielski is a research analyst at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;
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