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Using a Value Line Report: The Home Depot – September 30, 2011
Surfers often use the term “killing it” to describe someone who is riding a wave with particular skill. This admiration could easily be given to The Home Depot (HD – Free Value Line Research Report on Home Depot), as the company’s results have been top notch compared to its main big-box competitor Lowe’s (LOW).
While both companies reported respectable earnings in their fiscal second quarters (each company’s fiscal year ends in July), comps were the big difference. The term comps is unique to retail-oriented companies, such as retailers and restaurants. It stands for comparable-store sales, and is meant to show how well stores that have been open for at least a year have been performing.
The idea behind comparable-store sales is that a retailer can grow in two ways, by adding new locations or by increasing the amount it earns at existing locations. Weak results at existing stores can get overshadowed when aggressive store additions are driving overall results. However, Home Depot and Lowe’s are far more mature, so comparable-store sales are extremely important and often take center stage during earnings calls.
In Home Depot’s fiscal second quarter, comparable store sales improved 4.3%, as noted in the Analyst Commentary written by Matthew Spencer. This was actually better than the company’s overall sales increase of 4.2%. If Spencer were a surfer, he would likely say that Home Depot was truly “killing it”. Lowe’s, meanwhile, saw comparable-store sales fall 0.3%.
The Graph on Home Depot’s report wouldn’t particularly inspire confidence that this performance mattered, as the shares hit a peak for the calendar year in the first quarter. That said, there is a small, but perceptible tick up in the dotted line on the graph, which denotes relative strength. A rising line means the stock is performing better than the average stock while a falling line indicates the reverse. The upward tick suggests that the market has, in fact, taken note of Home Depot’s relatively strong showing.
In fact, the company appears to have earnings back on the right track. An examination of the Statistical Array shows that earnings took a material hit both leading up to and through the 2007 to 2009 recession (noted on the Graph with a gray bar), falling from $2.79 a share in 2006 to a low of $1.66 in 2009. This led to the –4.5% trailing annualized growth rate for earnings shown in the Annual Rates box. Clearly, the company faced some rough surf during a housing-led recession.
Home repairs, however, can only be put off for so long. And remodeling an existing home is usually cheaper and easier than selling a house in a bad market and buying a new one. Since Home Depot serves a broad audience of individuals and professionals, often those who do home repair and remodeling work, the company is in prime position to benefit as people start spending again. Although near-term results are likely to be hurt by a still difficult economic environment, as noted by Spencer in the Analyst Comment, he believes the company is on pace to earn between $2.30 and $2.40 a share in fiscal 2011. Over the next three to five years, Spencer projects earnings above the peak levels reached in 2006 (projections are found to the right of the Statistical Array).
The projected share earnings over that span of $3.15 suggests annualized earnings growth of about 9.5%. Although the recent soft patch, which led to the –4.5% growth rate over the trailing five years, has much to do with the increase, that doesn’t change the fact that 9.5% annualized earnings growth is pretty impressive for a retailer as large as Home Depot. (The figures can be found in the Annual Rates box.) The earnings advance also corresponds to a share price range of $45 to $55, between 30% and 60% above recent share price levels. Including the company’s solid dividend yield of around 2.9%, this results in an annualized total return range of 9% to 14%.
Though it would be hard to say that such a range was “killing it” compared to the broader market, adding in the company’s top-notch Safety Rank of 1 (Highest), found in the Ranks box, makes for an impressive risk/reward combination. Spencer notes in the Commentary that he expects earnings to grow at a double-digit clip this year and next, making the recent price a potential bargain.
That said, the stock isn’t as cheap as it has been in recent years, but those years included not only the recession but also a period in which the markets were concerned about management’s corporate direction. Indeed, the recent P/E ratio of 14, found in the Top Label, is about on par with the market’s P/E (as noted by a Relative P/E of 1.04). This compares to relative P/Es well below 1 between 2004 and 2008, as can be seen in the historical portion of the Statistical Array. Still, prior to this spell, Home Depot’s stock regularly traded well above the market’s P/E. So an increase to higher relative P/E levels from here isn’t out of line with the company’s longer-term history, assuming that management is, indeed, heading in the right direction.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.