One of the joys of being a securities analyst is reading conference calls when a CEO goes AWOL and tells people what he or she is REALLY thinking. This week, on the Restoration Hardware (Ticker: RH) Q4 2021 conference call, Chairman and CEO Gary Friedman did not hold back at all on sharing his views on the looming pressures on U.S. companies and consumers. He even invoked a Global Financial Crisis era reference comparing the current moment to the time when bank stock CEOs were talking about buying back stock while their stocks were plummeting and their counterparties were getting worried about continuing to trade with them. The implication is that while oblivious investors appear to think all of the recent inflationary pressures and geopolitical issues are transient and/or not material to companies’ cash flows and growth, the reality on the ground is that things are quite ugly.

By the way, the company also mentioned that growth has dropped by 10-12% since Russia invaded Ukraine. All this brings up a number of questions. Will U.S. consumers stop spending like they did back in 2008-09, the opposite of what happened during initial COVID outbreak? What will be the near-term impact of higher gas, food and rental prices on consumer sentiment and behavior? What will higher interest rates do to housing prices, demand for new homes and all of the economic activity that is intimately tied to housing? Our crystal ball is admittedly just as cloudy as is anyone else’s. However, we have intentionally stayed away from “COVID winners” in the consumer space; think companies that sell $4,000 mattresses, manufacture RVs and ones that benefit from everyone deciding to do home improvements projects all at once. We have viewed those companies as over-earning and have been very cautious about extrapolating recent trends and earnings power. In fact, the consumer discretionary exposure we have across our strategies includes companies that sell:

• Vitamins and supplements (NATR);
• Low priced shoes and apparel (SKX);
• Affordable luxury handbags and accessories (TPR);
• Inexpensive home, gardening and pet-related products (SPB); and
• Tickets to regional amusement parks (SIX)

If the RH CEO is correct (see the excerpt from the CapitalIQ transcript below) to be concerned about U.S. consumers’ willingness to continue to spend on discretionary items, then for sure all of the above companies will be impacted to some degree. However, they all have the balance sheets to continue to operate and invest even during a period of consumer uneasiness. They also sell either inexpensive items or products and forms of entertainment that could benefit from a trade down. Have you looked at how expensive a day at Disneyland has become, what a pair of Nikes is going for or how much Louis Vuitton has raised prices on its bags? Instead, why not spend the day walking around a Six Flags park in a pair of Skechers Street shoes while carrying a very affordable Kate Spade purse?

Steven Paul Forbes (Guggenheim Analyst)

Gary, super helpful, right? Because I think as we try to contextualize the prudence of the guide, it almost appears like you’re not incorporating a contribution from a lot of these year of the new factors, right? I mean, any comment on how you sort of built the guide from a bottom-up standpoint or how you would define the prudence behind it? And you have a great track record here. So any thoughts on just the guide in a holistic context on just the prudency behind it?

Gary G. Friedman (RH Chairman and CEO)

Yes. Well, look, I mean, it’s probably one of the most difficult guides since 2008 and ‘09 because we’re right in the middle of this disruption from Ukraine and Russia, which I think — I don’t think it’s all Ukraine and Russia. I think it’s triggered a greater awareness. Like it’s like someone — I think this was ring the bell, everybody pay attention. And then all of a sudden, everybody started talking. Yes, all of a sudden, the Fed’s off to the races, and that creates concern. You’ve got housing prices at all-time highs. I mean, is it sustainable? I don’t know for how long the math. Yes, doesn’t make sense on kind of what’s happening in the housing sector and other places that — you’ve got inflation like I’ve never seen.

Now I was telling people when Yellen said, “We’re going back to 2%,” we were just signing our new freight contracts, ocean freight contracts. I just wonder if anybody — the Fed has picked up the phone and called a businessperson and said, “Hey, what do you think is happening with inflation? How’s ocean rates? How is this? How is that?” I mean, I think — I don’t think anybody really understands what’s coming from an inflation point of view because either businesses are going to make a lot less money or they’re going to raise their prices. And I don’t think anybody really understands how high prices are going to go everywhere, in restaurants, in cars and everything. It’s — and I think it’s going to outrun the consumer. And I think we’re going to be in some tricky space.

So everything is kind of happening at once. And I think you got to prepare for war. I mean, if you’re going into a very difficult, unpredictable time, you just got to be super flexible. You’ve got to be able to improvise, adapt, overcome and kind of be ready for anything. And I don’t mean that by playing defense. I mean it by playing offense, but it’s — I wouldn’t call it happy days right now. I’d call it pensive days, be ready. And when we play like that, we usually have our best outcome. When we get overly optimistic, we have a higher likelihood to wind up in the ditch and get ahead of ourselves.

So — but if everything — if the war in Ukraine ends and inflation slows down in some miraculous way, I don’t know, everybody can sign new freight contracts because, I mean, most of the world all signed new freight contracts. 2 years ago, price of a container for us went from $2,400 to $4,800?

Jack M. Preston (RH CFO)

About that.

Gary G. Friedman (RH Chairman and CEO)

Yes. Yes, it doubled. I’m not going to tell you what it just went to. But just let’s say, that looked like a nice increase. So — and it’s not just us. It’s everybody. So either people are going to do stupid things like take quality down to make their goods like — look like it’s better value or they’re going to not — they’re going to have to take prices up. And — or they won’t take prices up, and they’ll hurt — their margin profile is going to change.

But it’s not just us. It’s everybody I know in every industry. And I just don’t think it’s like — again, I don’t want to scare everybody. But I talked about the theme, like there’s this scene in The Big Short where everybody is in that ballroom and the guy — I think it’s the guy from Bear Stearns or someone is up there, one of those things, and he’s saying how they’re going to buy back $1 billion of their stock, this, this and that. And then one guy who’s on his BlackBerry, he goes, “Can I ask a question, sir? In the 20 minutes that you’ve been talking, your stock is down like 55%.” And everybody ran out of the room.

I just think we tend to just try to be transparent and honest. And look, maybe our stock is going to take a big hit because of this, and people are going to think Gary Friedman wasn’t excited. I’ve never — I told my team, I’ve never been — in my 22 years here, I’ve never been more excited. I’ve also never been more uncertain, right? So — and I think you have to take a real balanced view right now.