At a time when the housing sector is in dire need of a shot of adrenaline, the world’s largest home improvement specialty retailer, Home Depot Inc (HD, Financial), has a lot going on for itself. The company which functions on a diversified scale with products and services ranging from various building materials to offering home maintenance and other related services has come back in focus, owing to a prospective recovery in the housing market. Therefore, let us analyze if Home Depot is a worthwhile investment idea in keeping with the current scenario.
Highlights from the past
Before drilling into the recently reported results, a bird’s eye view of the previous performance of Home Depot shall prove useful for the readers. For a head start, calling financial year 2011-12 as the golden period for the company cannot be rendered as a fair observation. In the year 2011-12, the shares grew by over 120%, which made Home Depot the best-performing member of the Dow-Jones Industrial average at the time.
Consequently, in order to sustain its leadership in the industry, the retailer has been spending more than $1 billion annually on capital expenditures. Investors’ concern regarding such high capital expenditure that resulted in reduction of buyback programs has also been tackled very well by the company. In the first half of 2014 alone, it spent $3.5 billion on stock repurchases. Even in the third quarter, the company repurchased $2.24 billion worth of shares under their Accelerated Share Repurchase (ASR) program. For the entire fiscal 2014, the company has planned to buyback $7 billion worth of shares which implies that in the fourth quarter, it will repurchase another $1.26 billion worth of shares. The point I am trying to drive home is that Home Depot has been consistent with its commitment to drive shareholder value.
In the coming fiscal, it may not be entirely wrong to assume that the company will be able to drive shareholder value at a better pace. As data shows, the pace of housing recovery has picked up and analysts are predicting that the recovery will completely unwind in 2015. Home Depot’s resources and presence across the U.S., Canada and Mexico regions will help it optimally leverage the recovery.
Continuing the momentum
In the third quarter as well, Home Depot delivered an outstanding performance owing to the housing recovery. The most evident point highlighted in the result has been the steady leap in the diluted EPS of 21.1% from $0.95 to $1.15 attributable to a 5.4% increase in the sales, which came in at around $20,516 million this quarter. Six new store openings, five in Mexico and one in Canada, during the quarter is also a considerable development for the company’s future prospect. The gross margin increased by 10 basis points, compared with last year.
Furthermore, in order to boost its revenue the company has been revamping itself by concentrating on square footage growth and increasing productivity from its existing store base. Also capital expenditure is seen to be kept on check as the company has recently entered into an agreement to purchase substantially all of the assets of HD Supply Hardware Solutions, a leading supplier of builders’ hardware to retailers in the U.S. It is significant to note that Home Depot has been its largest customer, contributing to almost 98% of its sales.
Takeaway
Home Depot’s shares have been on a roll since the announcement of its Q3 results further amplified by its recent decision to buy HD Supply Holdings’ hardware solutions business. The company, as a forward looking exercise, also aims at targeting its payout at approximately 50% of its earnings. Such a target and payout pattern is evident of the fact that the company enjoys a stable cash position and has free cash flow generating capacity.
However, one apparent downside is that it is an expensive stock priced at 20-times the average of the next two years’ forecast per-share earnings. Home Depot’s stock-price-to-sales ratio, a common parameter used for retailers, is over 1.5. This number is among the highest in an industry where the likes of Costco Wholesale Corp (COST, Financial), Target Corp. (TGT, Financial) and Home Depot rival Lowe's (LOW, Financial) have ratios below 1.
Yet the $131.50 billion company has its strengths rooted in multiple areas such as its solid stock price performance, impressive record of earnings per share growth, revenue growth, notable return on equity and expanding profit margins. To add to that, the company has historically responded well to changing conditions. Such strong positives easily outweigh the expensive price at which the stock trades and hence is definitely a strong buy option for investors looking forward to earning solid returns.
