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Patricio Kehoe
Patricio Kehoe
Articles (164) 

An Investment With Soild Foundations in the Specialty Retail Sector

February 24, 2014 | About:

Home Depot Inc. (NYSE:HD) operates home improvement retail stores in the U.S., Canada and Mexico. Since its beginnings in1978, this North American company has grown to become the world’s largest operator in the industry, based on net sales. Through more than 2,200 warehouse-format stores, the firm offers a variety of national brand names as well as proprietary items. Its wide product assortment includes home improvement, lawn and garden products, building materials and a number of related services. The company captures almost 20% of the domestic market share.

Growing its Core Business

Since 2007, the company has undertaken a number of initiatives directed to focusing its efforts on what has always been Home Depot’s core business, its orange-box stores. To this aim, the firm sold its professional supply business that year, closed its ancillary retail business in 2009 and withdrew its retail operations in China in 2012.

Instead, the firm updated its distribution network, which had failed to efficiently supply its stores after Home Depot’s aggressive domestic expansion in the previous years. Thus, the company developed a regional network and implemented rapid distribution centers. As a result, supply-chain efficiencies boosted, allowing better merchandise capabilities and, therefore, better store pricing and fewer markdowns. Hence, the firm is expected to achieve an era of structurally higher margins.

Solid Fundamentals

Home Depot’s economies of scale provide the firm with sturdy cost-advantages. And the firm passes along these advantages to consumers in the form of everyday low prices, which has generated strong customer loyalty. This appeal is further empowered by the brand equity attained through years of hard work on customer service excellence. The company’s staff has a solid knowledge base that has resulted in a long and efficient problem-solving trajectory that customers rely on. This intangible asset isn’t easily replicable, which poses an important competitive advantage, with Lowe’s Companies Inc. (NYSE:LOW) being the only rival to offer something that comes close.

Efficient Capital Strategy

Home Depot has made the best of its wide economic moat, achieving an average return on capital of 14% in the past five years. These results are even more encouraging when we consider the steep downturn in the domestic housing business during the great recession. Therefore, management expects its consistent margin expansion to be supported also by the gradual recovery of the housing market.

Furthermore, the firm will continue to strategically administrate its capital, making investments to develop its business and using an important part of its cash to enhance shareholders’ value through share repurchases and dividend payout. Thus, its target is to achieve a dividend payout of 50% and share repurchases for $17 billion by the end of 2015.

A Solid Investment

Home Depot strengths are highly visible from many positions. For one, the firm showcases an outstanding return on equity of 25.50 compared to its rivals’ 9.10 average. Its earnings per share growth is also impressive, averaging 24.10% compared to an industry median of 13.10%. Dividend Payout is higher as well, with 0.40 compared to its rivals’ average of 0.32. Moreover, the firm boasts an operating margin of 10.40% almost doubling its competitors’ average of 5.40%. Home Depot’s stocks trade at 20.80 its trailing earnings compared to the industry median of 18.00, and its sturdy earnings per share growth will make multiples increasingly compelling. In fact, investment guru Joel Greenblatt (Trades, Portfolio) recently increased its holdings by 78.07%, following my conviction about Home Depot’s powerful growth potential.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.2/5 (5 votes)


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