Home Depot Inc (NYSE:HD) disappointed investors with a rare soft earnings report on Tuesday. The company did beat on EPS by two cents. It came up very short on the revenues line, however, with $24.9 billion in sales falling $270 million short of expectations. That left Home Depot with just a 4.4% year-over-year growth rate. That wasn’t enough to please investors. HD stock is trading down modestly following its earnings report.
That may not be a fair reaction, however. As we’ll see in the pros and cons below, the earnings miss was largely driven by the weather. Bulls and bears disagree on the broader ramifications of that. Zooming out, Home Depot is the best player in its field, but its stock also fetches a premium valuation. That said, is Home Depot stock worth buying today?
HD Stock Cons
Will 2018 Miss Guidance?: HD stock bulls will say that this sales miss was weather-driven and not important. They have a valid point. But they could be wrong.
Reuters quoted an analyst who doubted that Home Depot will make up all the lost sales in future quarters: “The lower-than-expected sales could pressure Home Depot’s ability to meet its full-year targets,” Loop Capital analyst Laura Champine said. “How much of the sales they’ve missed will they get back? That’s the key.”
Indeed, given Home Depot’s steep discounting on items such as patio furniture, the company may see a more than one quarter impact on its profitability.
Largely Played Out Market: Within the United States, there’s likely not much opportunity for additional stores. For example, in the latest quarterly report, we see that Home Depot added just four net stores over the past year.
That means that growth opportunities going forward will be diminished. The company has done well internationally. It is one of Canada’s largest home improvement chains. Additionally, it has more than 100 stores (and growing) in Mexico, which should be a booming market in coming years. All that said, without much growth opportunity in the United States, expect long-term margins to decline as competitors cut prices to try to maintain market share. As a mature market, investors shouldn’t expect the same eye-popping growth that Home Depot stock previously delivered.
More Expensive Than Lowe’s: HD stock is significantly more expensive than stock in its chief rival, the Lowe’s Companies, Inc. (NYSE:LOW). Lowe’s stock is selling at 21x trailing PE and 14x forward PE. That matches up favorably against Home Depot stock at 25x trailing and 19x forward PE. The comparison looks even worse for Home Depot once you realize that it has a far more leveraged balance sheet than Lowe’s which should, in theory, make Home Depot more profitable.
On a revenues basis, HD stock also looks pricey. The market values HD stock at $221 billion for $100 billion in annual revenues. Whereas Lowe’s has a market cap of $72 billion against $69 billion in revenues. That means that the market is willing to pay a dollar for a dollar of Lowe’s revenue, but more than 2x that for a dollar of Home Depot revenues. Home Depot has the better brand, but is it worth that much of a premium?
HD Stock Pros
Earnings Softness Was Weather-Driven: Home Depot’s management said that unusually cold weather this spring caused the earnings miss. Due to abnormally chilly conditions across much of the U.S., folks delayed the start of their gardening and yardwork this year. That led to, predictably, serious volume declines for products such as fertilizers. Specifically, that led to the CEO stating that: “The miss in terms of garden was significant against what we planned”.
Management suggested this was merely shifted demand, not an overall loss. So far, the company sees May sales growing at a double-digit rate, making up for much of the first quarter’s shortfall. Overall, that allowed Home Depot to maintain guidance for the full year. On the whole, the bulls say that the earnings miss won’t have lingering effects for Home Depot stock.
Web-Resistant Retailer: Retail used to be a classic sector for investors. Lately though, given Amazon.com, Inc.’s (NASDAQ:AMZN) monopolization of wide swaths of the retail landscape, investors have given up on shopping investments.
Home Depot stock, however, has fared well despite the so-called retail apocalypse. There are several good reasons for that. For one, Home Depot has expanded internationally in Mexico with its huge construction market. Within the U.S., do-it-yourselfers seem to still benefit from having in-store help to guide purchases. Also, for certain projects, getting a part or tool is an immediate need, where the consumer won’t wait two days for delivery. Finally, many of Home Depot’s products are heavy or bulky, making online shipping uncompetitive with the company’s streamlined supply chain.
Huge Dividend/Buyback: HD stock treats its shareholders well. Management has been jacking up the dividend for more than a decade now. Over the past 10 years, it has averaged a 16% compounded dividend growth rate. During the past five years, as the housing market recovered, management has gotten even more generous, with a 24% dividend growth rate.
That means that while Home Depot stock yields 2% now, a buyer five years ago is now getting 5.7% on their initial investment. Don’t overlook the power of a modest starting yield that grows explosively. On top of that, Home Depot is buying back tons of stock. Since 2010, the amount of Home Depot stock outstanding has plunged from 1.8 billion shares then to just 1.15 billion today. That creates a ton of value for the remaining stockholders and supercharges returns and dividend growth.
HD Stock Verdict
Home Depot is the best-in-class retailer in its niche. It’s largely Amazon resistant, and has built a nice web presence itself. Furthermore, its international efforts, particularly in Mexico, give it further growth opportunities even with the US market tapped out.
That said, HD stock is expensive in its own terms and compared against Lowe’s. The U.S. market is unlikely to perform nearly as well as in the past, leading to falling profit margins. Home Depot is a great company, but the stock price reflects that already. As for what the stock will do for the remainder of 2018, much will come down to whether this earnings whiff was a one-off or the start of a problematic trend.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.