Loading...
 

Home Depot (HD - Free Home Depot Stock Report) shares had a fine 2013, climbing around 35%, to a record high in the low $80s. In fact, the Dow component seemed to have the wind at its back throughout the year, thanks to information technology and supply chain upgrades, good expense leverage, market-share gains, and the early stages of what promises to be a lengthy housing recovery. These factors likely supported same-store sales growth in the 7% area, modest margin expansion, and an impressive share-net advance of about 20%. (Note that the company’s fiscal year ends on the Sunday closest to January 31st.) But what should investors do now? Will the good times continue to roll for this giant specialty retailer and its shareholders? Or are investors best advised to seek out greener pastures at this point, with the stock’s valuation haven gotten a bit too rich? In this article, we will attempt to address these questions by taking a brief look at Home Depot’s business and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.

The Business

Home Depot, founded in 1978 and headquartered in Atlanta, Georgia, is the world’s largest home improvement retailer, with over 300,000 employees and annual sales of nearly $80 billion. Serving both the do-it-yourself and professional contractor markets, the company maintains a network of roughly 2,260 big-box stores in the U.S., Canada, and Mexico that sell a wide assortment of building materials, home improvement products, and lawn and garden products. It also provides numerous services to do-it-for-me customers, installing everything from carpeting, flooring, and cabinets to roofing, windows, and central air systems.

Strengths

Excellent Execution: This prevented Home Depot from falling off a cliff during financial crisis and recession. Notably, even during the worst of times, annual earnings never dipped below the $1.66-a-share mark (recorded in fiscal 2009), and the company was able to maintain its healthy dividend payout. Execution is apt to remain first-rate, too, which should lend support to margins and allow the retailer to wrest further market share from rivals, the principal one being Lowe’s Companies (LOW).

Product Innovation: Home Depot has been the fastest growing retailer in U.S. corporate history, a feat largely achieved because of its strategic product alliances with industry-leading manufacturers. Indeed, these alliances have enabled the company to deliver exclusive, innovative assortments to do-it-yourselfers and professional contractors alike, with a combination of national brands and propriety products, such as Ryobi tools, RIDGID tools, BEHR paint, LG appliances, and Toro and Cub Cadet lawn equipment.

Professional Clientele: A lot of Home Depot’s business comes from professional contractors that place sizable orders. In fact, professional sales currently account for around 35% of the top line. And we expect them to become an even greater part of the mix going forward, as the company rolls out new services, from e-receipts to a new mobile app and loyalty program, catering to the fastidious professional crowd.

Shareholder Friendly: The company generates ample free cash flow, a good portion of which it typically returns to shareholders in the form of dividends (the yield has been hovering near 2%) and stock buybacks. Impressively, over the past decade, approximately 40% of the outstanding shares have been retired. And CEO Frank Blake, who took his seat in the corner office in early 2007, remains committed to repurchases as a way to bolster share earnings and enhance shareholder value.

Weaknesses

Relatively Small Online Presence: This makes Home Depot vulnerable to large Internet-based retailers, such as Amazon (AMZN), that may be able to undercut it on price in some cases and even guarantee quicker home delivery. Still, the company is stepping up its ecommerce efforts, endeavoring to provide its customers with an interconnected retail experience. And it is extending its distribution network, which ought to enable it to catch up with online rivals on the order fulfillment and direct delivery fronts.

Opportunities

Housing Recovery: Conditions have improved a lot since the 2007-2009 recession, with affordability now rather high and housing formation finally starting to turn the corner. Home values also continue to appreciate across the country in what will likely be a lengthy, multiyear upcycle. This is leading to greater home investment, and it will likely keep the same-store sales (and earnings) momentum going for some time to come. In fiscal 2014, we see the top line rising at a strong 5% clip, with share net apt to climb in the 15%-20% range, to $4.40 or so.

Heightened Maintenance Demand: This has resulted from an aging of housing inventories across the country. And it, along with cheap financing options, is contributing to a favorable uptick in renovation activity.

Unit Expansion: There are eight new stores planned for 2014, down from the recent pace of closer to 12 per year. Yet, development opportunities remain plentiful, particularly as Home Depot looks to make inroads overseas, in China and elsewhere, with smaller specialty outlets, including ones focused solely on home decorations and paint and flooring.

Productivity Initiatives: As 2014 gets under way, the company has numerous productivity initiatives in place that should keep a lid on SG&A expenses and support double-digit share-net growth. Among these are measures to improve merchandise execution, order management, and space optimization, along with efforts to drive more inventory and supply chain efficiencies.

Threats

Rising Interest/Mortgage Rates: This could have a chilling effect on consumer spending and the overall housing recovery. That said, we expect borrowing costs to stay historically low even as the economy strengthens and the Federal Reserve winds down its accommodative bond-buying program. And home buying should remain an attractive option for many consumers, particularly with rental prices soaring in many American cities.

Bad Weather: In any given year, cold and stormy weather can wreak havoc on customer counts and depress key same-store sales trends. The January interim, usually the company’s weakest quarter from a revenue standpoint, is the one most likely to be hampered by weather-related headwinds.

Conclusion

In sum, we believe that Home Depot’s strengths and opportunities, highlighted by ongoing productivity enhancements and a further rebound in the national housing market, now far outweigh its weaknesses and threats. And while this quality Dow issue appears fully valued at the recent quotation (it is trading at a forward P/E multiple of about 20), we still think that it’s a good choice for conservative investors seeking exposure to the resurgent housing sector. We would be especially bullish on the stock in the event of a material price pullback, which could well happen if the broader equity benchmarks enter a correction phase.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.