Home Depot Inc (NYSE:HD) delivered a solid beat on earnings expectations for the third quarter ending in September. And yet, HD stock is actually falling in trading right now.
Silly, silly, silly.
Two headlines from Bloomberg News told the tale. The first, issued after the earnings report, was “Home Depot Profit Tops Estimates as Remodeling Spree Continues.” After trading opened, the headline was changed to “Home Depot’s Tepid Sales Forecast Signals Homeowner Caution.”
What happened was that Home Depot’s earnings call issued conservative guidance for Christmas and beyond. Unable to see policy certainty following the election of Donald Trump, management decided to err on the side of caution. As a result, HD stock fell from a very rich valuation of 21 times earnings and almost twice sales going into earnings. This comes at a time when other successful retailers are selling for half sales.
The Results Looked Good, But …
Home Depot earned $1.969 billion, or $1.60 per share, on revenues of $23.154 billion for the quarter ending in September. Compare that to earnings of $1.725 billion, $1.36 per share, and revenues of $21.898 billion for the same quarter a year ago.
Year-over-year, earnings were up 14% on a sales gain of 6%, with almost $1 in every $10 in sales falling to the net income line. That’s an awesome margin in a business where giants like Wal-Mart Stores, Inc. (NYSE:WMT) are fortunate to bring 4 cents in every dollar to the bottom line.
The press release also offered reaffirmed 2016 sales guidance, with sales up 6.3%, comparable-store sales up 4.9% and earnings per share of $6.33 — 24 times its stock price.
But a closer look at the figures showed reasons for caution. Sales growth is slowing — it was 7.2% for the first three quarters, and if it’s up 6.3% for the full year, Christmas should see a sales gain closer to 5%. Long-term liabilities are up significantly from a year ago, and free cash flow — the total change in cash from year to year — was up just $14 million from a year ago.
Is Home Depot Stock a Trump Victim?
A policy aimed at increasing inflation and interest rates, which is signaled by the Trump administration, could prove very, very bad for housing, and for Home Depot’s customer base.
Rising interest rates will hit mortgages hard, and could make new loans less affordable, especially the second mortgages used to finance major home repairs. HD stock has doubled since the start of the current recovery, but during the 2000s, its value fell 28%, even though its dividend rose steadily and was maintained during the financial crisis.
Both the end of the dot-com era and the collapse of the housing bubble hit the stock.
Home Depot bulls remain, arguing that its valuation relative to earnings and growth makes it attractive. The company is also said to be “Amazon-proof,” able to weather efforts of Amazon.com, Inc. (NASDAQ:AMZN) because such things as lumber can’t be mailed. But traders’ strategy to take advantage of this often include options, which can magnify small gains.
Home Depot, in short, was fully valued by the market before earnings. Anything that might sound like potential weakness was bound to be punished.
Buy, Sell or Hold HD Stock?
Home Depot remains a fabulous company — a good bet for the long term — but a mere maintenance of guidance was bound to cause bearishness in investors who were pricing it to perfection.
Most analysts called Home Depot stock either a buy or a strong buy ahead of earnings, and none advised selling. So the fact that HD only matched a whisper number on earnings of $1.60 made it easy for traders to abandon ship.
Investors, on the other hand, should not drop HD stock. Not unless you want to take some fat profits and have something else to do with the money.
Dana Blankenhorn is a financial and technology journalist. His latest novel is Bridget O’Flynn vs. Something Big & Ugly. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities.
