If you have tried to purchase music from a retail store any time in the last few years, you may have noticed that it’s increasingly difficult to do. Simply finding a dedicated music retailer is hard enough, but finding a store with a varied selection of music is becoming harder and harder. If you do happen to find one of the few remaining dedicated music stores, the selection is usually focused on best sellers (old and new)—you might also notice that movies, video games, and collectibles are taking up more space than the music.
You can still buy music on compact disks at large chain stores, like Wal-Mart (WM – Free Wal-Mart Stock Report) or Target (TGT), but the selection is usually limited to what is new and broadly popular, as older titles don’t sell well enough for the stores to bother stocking them. So you might find a “best of” album for your favorite ‘60’s rock group, but you probably won’t find each album they put out.
What happened? If video killed the radio star, then the Internet killed the music retailer. Apple (AAPL) and Amazon (AMZN) both provide compelling services that allow music aficionados (and those who just like a catchy tune) to buy music and put it onto one of the many devices that now store and play digital music. The music business isn’t dead, people still love to listen to music. The music business has just changed—a lot!
The music business is a well-developed example of a major change taking place across many retail categories. Media channels are filled with stories about customers going to their local Best Buy (BBY), checking out the selection of items, and then promptly going home to buy the very same thing online for less—with no tax and, in many cases, no shipping charges. In fact, it is becoming increasingly possible to order from an online competitor in the store using an Internet connected device like a smart phone.
Many traditional retailers (the ones with stores) are working hard to bolster their web presence. The hope is to sell to the customer who is simply window-shopping. But certain retail categories are less prone to window-shopping followed by buying elsewhere. Hardware stores are one area where the Internet has yet to play a big role. The Home Depot (HD – Free Value Line Research Report) is the leader in this space.
Sure, you can buy all sorts of hardware items online, but buying a rake, pipes, wood, and other large items isn’t really easy to do online. For starters, the shipping costs of a sledgehammer or other large heavy tool would be significant. Second, many items in hardware stores, such as wood and pipe, are simply too large to ship. Third, some items are time sensitive—if your toilet is broken, waiting for the delivery of a new part that costs only a few dollars is not usually a viable option.
While The Home Depot’s product offerings provide a moat of sorts against the onslaught of the Internet, the company isn’t sitting still waiting to be attacked. It has a well established website that benefits from its brand name in the hardware store space. However, it is not a material portion of the company’s business for the reasons noted above. One could consider the company’s online retail site as an extra wall on the other side of the moat.
This alone, however, doesn’t make The Home Depot a great investment. The Internet isn’t the only threat the company faces. True, the big box retailer has handily destroyed the mom and pop hardware store business in most of the country, but there are other chains hot on the company’s coat tails. The leading contender is Lowe’s (LOW). Still, The Home Depot has done well in this battle, even as both companies are increasingly competing for customers.
The Home Depot, with over 2,200 stores, took material revenue and earnings hits in 2008 and 2009. The historical portion of the Statistical Array shows that sales and earnings peaked in 2006 at $46.11 and $2.79 per share, respectively, and then fell to $38.84 and $1.66 per share, respectively, in 2009 before rebounding in 2010. The store count stagnated somewhat in the span as well, as the company trimmed its expansion plans and closed its EXPO Design Stores (store count is another figure shown in the Statistical Array for retailers).
Clearly the recession (the shaded area on the Graph starting in late 2007 and extending into early 2009) and housing bust were to blame for the company’s sales and earnings woes. What is impressive, however, is that The Home Depot appears to have weathered the storm easily and is now back on track, as 2010 financial results show. Moreover, analyst Matthew Spencer’s estimates and projections (shown in bold in the Statistical Array) outline solid, if not spectacular, growth ahead.
In fact, Spencer’s three- to five-year estimates suggest annualized revenue growth of about 4% per year, which can be seen in the Annual Rates box to the left of the report. Although this is below historical growth rates, the company is much larger now than it was 10 years ago (in 2001 the company had about 40% fewer stores than it had at the end of 2010). Note, however, that annualized earnings growth is expected to be about 7.5%, quite close to the longer-term average and well above the flat growth seen over the previous five years.
This earnings advance suggests a share price target over the three to five year period of $45 to $55. This range is displayed visually by the dotted lines on the far right of the Graph and in number form in the Projections box. The percentage gain that this price range implies is 25% to 50% over the period. Add in the company’s solid and growing dividend, and the annualized total return Spencer expects is between 9% and 13% per year.
While this would be a solid, though not spectacular, performance, it must be juxtaposed against risk. The Home Depot is a rock solid company. If its ability to take the housing crash and recession in stride isn’t enough evidence of this, then consider the company’s high scores for Financial Strength (A++ is the highest possible rating), Price Stability, and Earnings Predictability. Each of these proprietary figures can be found in the Ratings box at the bottom right of the report. The low score for Price Growth Persistence, meanwhile, is the result of the broadly sideways share-price performance seen since the company was a market darling in the late 1990s.
This performance isn’t unusual for a retailer, as the initial days of heady growth, fueled by aggressive store expansion and, often debt, inevitably lead to a larger, more mature company where corporate strategy has to expand beyond simply opening new stores. This transition was slow for The Home Depot, but its strength through the recession is evidence that it is has a solid handle on its business. Moreover, the company has begun to increase its dividend again after several years without an increase, raising the quarterly figure to $0.23625 per share last year from the $0.236 per share that had been in place since 2007. Moreover, the quarterly distribution was raised again, to $0.25, in the first quarter of this year. Quarterly dividend payments are noted in the Quarterly Dividend box at the bottom left of the company’s report.
Note, too, that as of January 30, 2011 debt only made up about a third of the company’s capital structure (noted in the Capital Structure box). Its debt payments are well covered by earnings and the total debt load is reasonable. This is particularly impressive, since the company’s inventory is costly in addition to being bulky. Its large stores are also expensive to build and maintain. Although the company recently sold $2 billion worth of debt, the proceeds will be used to pay down existing debt and buy back shares.
The company’s solid financial position leads to its stock receiving Value Line’s highest
possible Safety Rank, which can be seen in the Ranks box in the top left of every Value Line report. Note that the shares garner an average Timeliness rank, suggesting market-like performance over the next six to 12 months. With a relative Price to Earnings Ratio that is almost perfectly in line with the market (relative P/E is shown in the Top Label section of the page), this shouldn’t be surprising.
However, the longer-term, as noted above, appears fairly bright at The Home Depot. For more conservative investors, this would make a solid “old world” retail investment in an industry that is under attack from modern technology.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.