The home improvement industry experienced a surge in activity as the pandemic forced Americans to sequester themselves in their homes. Government stimulus checks, and the work-from-home trend added fuel to the fire. Many Americans, some flush with cash, remodeled their homes to fit their new lifestyles.
This paradigm shift lifted the stock of Home Depot (HD), but the company’s shares are down well over 20% year to date. This despite an impressive Q4 earnings report.
Pundits blame weak guidance, coupled with a belief that the torrid home improvement activity recorded during the pandemic will fade away, as the cause for the stock’s malaise.
While it is reasonable to question Home Depot’s growth trajectory, there are trends in place that could spur the stock to new heights. Furthermore, even though Home Depot stores blanket the US, the home improvement market is massive.
Last but not least, HD has an initiative designed to capture a bigger percentage of the large orders generated by pro shoppers.
A Look At Last Quarter
A bit over two weeks ago, Home Depot provided Q421 earnings. The company beat estimates on the top and bottom line with sales of $35.7 billion, up 10.7% year-over-year, and net income of $3.85 billion.
That translated to EPS of $3.21 per share, versus $2.65 per share a year earlier. Analysts’ forecasts were for EPS of $3.18. Operating income was up by 85 basis points year-over-year, an increase of 18.2%, to $4.8 billion, or 13.5% of sales.
The firm’s fiscal year ROIC increased to 44.7%, a significant surge from an already impressive ROIC of 40.8% a year earlier.
Comparable store sales grew 8.1% year-over-year, while U.S. comps saw an increase of 7.6%. For the FY21, the firm’s comp sales increased 11.4%, and U.S. comp sales increased 10.7%. Management cited a surge in pro sales as the cause of the increase.
Although comp transactions decreased 3.8%, the average ticket increased 12.3%. Two-thirds of the ticket growth was attributed to inflationary pressures.
Every merchandising category, and each of the company’s 19 U.S. regions, recorded positive comps.
Over the last two years, digital sales have more than doubled. Digital sales also increased at a 6% rate for the 4th quarter and a 9% pace for the year.
2021 revenue hit a record $151.2 billion, a 14.4% increase from 2020 levels. Earnings of $15.53 per share were up more than 30% year over year.
Sales hit a company-record $605 per square foot in FY 2022. This was driven in part by a growth in pro sales. That compares well to sales per retail square foot of $528.01 in Q4 2020.
HD budgeted around $3 billion in capex for FY23. An increase from $2.6 billion in FY22 and $2.5 billion in FY21.
Management guided for EPS growth in the low single digits and sales growth to be “slightly positive” in 2022.
A big takeaway from this earnings report is that sales growth was more robust among pros than the DIY crowd. Big-ticket transactions, the bulk of which stem from pros and represent around 20% of Home Depot’s US sales, rose 18%.
These Trends Are Your Friends
The cessation of government stimulus checks, the increase in mortgage rates, the reopening of the economy, and pandemic fueled growth that is seen as ebbing, are arguments provided by bears when considering an investment in HD.
However, there are a number of trends that could support the stock. Home-price appreciation, a lack of affordable housing on the market, an increase in existing-home sales, and the age of the nation’s housing stock, are factors that should fuel future remodeling activity.
Consider that home price appreciation can lead some to take out loans to finance remodeling, while aging homes may require home improvements.
Simple demographics are another factor to consider. A surge in home buying by younger adults is fueling remodeling demand. From 2020 through 2025, 11 million baby boomers will move out of their homes and be replaced by 15 million younger adults. Younger Americans undertake remodeling projects at a rate that is 35% higher than their elders.
The age of homes in the US also indicates the pace of home remodels and repairs should remain strong for an extended period. After all, some repairs are required due to the age of a home, and older homes often have an out-of-date look that may compel owners to modernize.
With the exception of Nevada, the median age of homes in every state is at least 30 years, while the median age of homes in 31 states is over 40 years.
Lowe’s CEO claims two-thirds of his company’s sales are non-discretionary. They are the sort of repairs that are common in older homes.
The wear-and-tear and the lack of housing pushes the consumer to think about ‘How do I improve the living space that I already have?’
Bill Boltz, Lowe’s Executive VP of Merchandising
During the last quarterly report, HD management noted pros spending per ticket was on the rise, an indication that the pace of home repairs and remodeling is still strong.
I mean, the conversations that we have with our Pros. They have basically been multiple weeks and months of backlog, and that continues. So I have not seen any major shift.
Craig Menear, CEO
While HD management provided a rather tepid forecast for growth during the last earnings call, the company’s preparation for this spring, the home improvement industries’ peak selling period, paints a different picture. Home Depot is hiring 100,000 full- and part-time employees for this season, a 25% increase from previous years.
Furthermore, a recent study forecasts a continuing demand for remodels over the short term. Harvard’s Joint Center for Housing predicts remodeling will continue to grow markedly for the first half of this year, reaching a peak in the third quarter. Thereafter, demand should slow to a normal growth rate.
Initiatives That Could Drive Continued Growth
Factors to consider when evaluating Home Depot’s growth prospects are the size of the home improvement market and the dominant position the company holds.
With an addressable market of over $900 billion, and a market share in the mid to high teens, there is significant room for Home Depot’s continued growth.
HD’s size and dominant position also provide a competitive advantage. HD has significant bargaining power due to its sheer size, and some of the savings gained when negotiating with vendors are passed along to consumers.
Consider that Menard’s, the number three competitor in this space, has 335 stores in 15 states. Contrast this with Home Depot: 90% of the U.S. population lives within 10 miles of at least one of the company’s stores.
The near ubiquitous nature of HD appeals to pros. About 45% of Home Depot’s total sales come from pro customers, while no more than 25% of Lowe’s stem from pros.
One path to increased growth may lie in an initiative Home Depot launched to cement and expand its standing in that community. Home Depot and freight technology company Loadsmart have partnered to build an automated, supply-led flatbed platform that will eventually service the 40 largest US metro areas. Management has dedicated $1.2 billion to the task of building the flatbed distribution centers and a total of 150 new distribution facilities.
The goal is twofold: to provide same or next day delivery to professional/contract customers, and to build the capacity needed to fulfill the needs of larger customers.
The following excerpt from the Q4 earnings call provides insight into the role the flatbed distribution centers can fill.
When we think about what we’re seeing in the Pro planned purchase, I mentioned this, I believe last quarter, that we’re seeing a redefinition of what we thought was a job lot quantity. We’ve always talked about being a project store, having job lots in the store. And I think I used an example of a foreign job, that we might have had 3-odd jobs worth of flooring in the store. So an average job might be 1,000 square feet. So we’d have 3,000 square feet in the store at any one time to satisfy three jobs. What we’re seeing going out of the flatbed distribution centers, orders of 7,000 square feet, completely redefining what a job lot quantity is.
Recently, in millwork, if you think of interior doors, we have different widths, right- and left-hand swing. We might have 20 doors in stock of any particular SKU. Just this week, we are delivering door orders of counts of 150 doors out of our FDCs. This is completely redefining our fulfillment capability with the Pro for their planned purchase. So that’s what we mean by disruptive.
I believe the flatbed distribution centers could provide a long growth pathway for Home Depot.
HD: Dividend, Debt, And Valuation
Home Depot’s board approved a 15% increase in its quarterly dividend. The current yield is 2.40%, the payout ratio is a bit above 44%, and the five year dividend growth rate stands at 18.27%.
Home Depot has solid investment grade credit ratings. Home Depot’s debt/EBITDAR ratio was 2.1X at the end of 4Q21.
Note the company also owns roughly 90% of its stores, including those that are on leased ground.
Aside from a rapidly growing dividend, HD rewards shareholders through a robust stock buyback program. The shares outstanding at the end of 2021 are roughly half that of 2007.
HD shares currently trade for $316.76. The 12 average month price target of the 26 analysts rating the company is $396.29. The average price target of the 15 analysts that rated the stock following the most recent earnings report is $352.40.
HD has a 5-year PEG of 2.58x, and a forward P/E of 19.80x. While the forward P/E is about 2 points below the company’s 5-year average P/E, the PEG is more than a half a point higher than the companies average for that metric.
Is HD Stock A Buy, Sell, or Hold?
There are pros and cons to weigh when considering a potential investment in Home Depot. On one hand, you have rising interest rates, runaway inflation, and a likely end to the robust growth the company experienced during the pandemic.
On the other hand, a shortfall in the housing supply that will prevail for years, the fact that most of the houses in the US were constructed decades ago, and a surge in home buying by younger generations all serve to fuel demand for home repairs and remodeling.
I believe the initiative to capture business from larger contractors/professionals by investing in flatbed distribution centers will drive growth.
Now add that Home Depot is the dominant member of a near duopoly, that the company has a strong debt profile, and that it is an exceptionally shareholder friendly company: management returned $67 billion to shareholders in dividends and share buybacks over the last half decade, roughly the equivalent of 20% of its market cap.
My sole cause to hesitate when considering an investment in HD is the company’s current valuation.
I believe HD shares are trading at the less attractive end of a fair valuation range. Consequently. I rate Home Depot as a HOLD.