The Home Depot Inc Stock Price Is Its Only Big Problem

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Home Depot, Inc. (NYSE:HD) is sitting in exceptional position as far as companies go. Just about everything is going right for HD, except that HD stock is too expensive to buy right now. Let’s take a look at all the cylinders that are firing well and how to play Home Depot going forward.

hd stock

Home Depot’s third quarter fiscal 2017 numbers were tremendous. Revenue was up 8.1% from Q3 2016 to just about $25 billion. Even better, its growth rate accelerated, compared to Q1 and Q2 revenue increases of 5% and 6.2% respectively.

The number I focus on the most, comparable store sales, was up a staggering 7.7% YOY. Just when I thought it could not improve, comps came in higher that Q1and Q2’s 6% and 6.6%, respectively. Meanwhile, HD stock had sales growth for online purchases increase by almost 20%.

There’s no fear that Amazon.com, Inc. (NASDAQ:AMZN) is going to impactHome Depot’s business. In fact, online sales were 2.4% of net sales in 2012 and have more than doubled to 6.2%.

Because of the higher margins and convenience of online shopping, HD pivoted away from opening stores to opening distribution centers. HD opened seven of these between 2012 and 2016, while only adding 22 actual stores.

Why so few distribution centers? Because HD has over 2,200 stores, and shipping can be difficult because many products are big and bulky. But with online ordering, consumers can put in their order and just waltz on over to a nearby store for pickup.

What percentage of online orders do you think get picked up in an HD store? My guess was about 20%. Turns out that number is closer to 45%, with 85% of online returns being done in the store.

It can be easy to get blindsided by other numbers if comps are doing well. For example, if expenses go wildly out of control, those comps may not mean much. However, operating margins are not only growing, they have been on a ten-year tear. In 2008, operating margin was 6%. This year it is just over 14%.

Home Depot has good times ahead. Management says that 6.5% comps can be expected for the entire FY17, and net income should grow by 14%. That’s simply fantastic. Meanwhile, the secular tailwinds should keep its stock flying. Homes over 25 years old make up more than 25% of the total market.

The economy continues to improve, and if GDP gets over 3% for good, it will lead to increased wages and more home improvement projects. While I am not crazy about Home Depot buying back lots of stock at these prices, and prefer they pay a dividend, it does represent the one downside with respect to capital allocation.

Spending $8 billion to buy overpriced HD stock does not sit well with me.  The dividend has been growing, but at 1.9% it doesn’t entice income investors. So the problem is HD stock price. TTM net income for Home Depot stock is about $8.6 billion.

However, with a market cap of $211 billion, HD stock trades at 24.7x net income. However, with earnings only growing at 14%, and even adding a premium that might push HD stock’s intrinsic value up as high as 18x, HD stock is just too expensive to buy right now. Hold it if you own it, though.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.


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