Shares of home improvement company Home Depot Inc (NYSE:HD) have suffered through mixed trading since the recently released February housing report.
HD stock is slightly in the red and has traded as much as 5% lower since the March 17 report, which showed that housing starts were up about 17% but new home sales were down 3.7% year-over-year.
Investors have been feeling skittish about HD stock thanks to the 50% gains it has tacked on since the start of 2014, representing the company’s biggest rally over the last five-year period. That’s because 2014 was an otherwise lackluster year for the construction industry due to weak consumer spending and a soft housing market. The situation was even bleaker for Home Depot after it suffered a massive credit card data breach.
Nevertheless, Home Depot stock managed to climb its wall of worry, and the company posted strong revenue growth.
HD stock was not the only homebuilder stock that was hammered by the news. Lowe’s Companies, Inc. (NYSE:LOW) was down as much as 5.2%, while SPDR S&P Homebuilders (ETF) (NYSEARCA:XHB) fell 3.2%.
Investors have every right to be concerned that the huge run-up in HD stock is close to maxing out; both it and Lowe’s are near all-time highs.
However, for several reasons, I believe Home Depot’s long-term outlook remains good. Let’s take a look at three.
Strong Online Business
Home Depot has bet big on its online business, and it looks like it’s paying off. While HD doesn’t break out online revenue figures in its quarterly reports, the company’s senior vice president of online operations, Kevin Hofmann, noted during the Goldman Sachs Dotcommerce conference last year that Home Depot’s online revenue grew a blistering 53% in 2013, much faster than the mid-teens to mid-20s online sales growth for the average retailer. Growth in 2014 averaged 40%.
Barron’s provided estimates mid-last year that Home Depot’s online revenue was about 3.5% of overall revenue. So, 40% growth would mean that the company’s online business brought in about $3.86 billion, or about 4.6% of revenue, in 2014. (The slowdown in online growth can be chalked up to the launch of the BOSS, or Buy Online, Ship to Store, initiative in 2013.)
HD is working hard to expand its online business. Home Depot recently opened three giant direct fulfillment centers; each facility can hold 100,000 products to be shipped directly to customers. Home Depot has 2,000 locations in the country from which customer orders can be delivered or where customers can return orders. This helps the company to ship most orders the day they are received. This is a significant advantage the company enjoys over rival Lowe’s, which lacks same-day delivery services.
Home Depot plans to build two more fulfillment centers in the current year, and has a target to deliver customer orders within 48 hours for at least 90% of the population.
Plenty of Home Improvement Going On
According to the National Association of Home Builders, the Remodeling Market Index, or RMI, reached an all-time high during the third quarter of 2014. The RMI is used to gauge the amount of remodeling activity going on by tracking sentiments by home remodelers.
The RMI reading has remained in the mid-50s for several quarters, which according to the organization is a positive sign that a steady recovery of the housing industry is likely to continue.
And investors need not worry that the housing construction industry is near a cyclical peak. Key indicators such as new single-family construction are still way below their average reading during boom times. Indeed, new single-family housing activity is usually 150% higher than other home improvements during housing peaks.
The reading for this indicator by the end of 2014 showed that new single-family housing was about even as other home improvements, meaning there’s still plenty of room to run.
Better Operational Efficiency
Home Depot not only is the industry leader in home improvement, with 54.5% share of the market compared to Lowe’s 38.5%, but it’s also superior in operating margins (11.6% vs. 7.9%) and return on capital (23.3% vs. 12.4%).
HD said during its latest earnings call that it expects revenue to grow 3.5%-4.7%, which is considerably slower than the 5.5% growth recorded in 2014. The company, however, is known to under-promise and over-deliver, so don’t be surprised if Home Depot exceeds projections.
The company also announced a huge $18 billion share repurchase program to be executed within a two-year time frame. That should cut its outstanding share count by 8.2%. Home Depot is a share buyback champ and has spent $53 billion in buybacks since 2002, cutting its outstanding share count by half.
Bottom Line
Even though the housing market has improved markedly over the past few years, Home Depot hasn’t run out of runway yet. HD stock is well-positioned to take advantage of the increased housing activity.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
