The probability of recession in the United States, as predicted by Treasury spreads, is at the highest level since the financial crisis of 2008-09. In such a scenario, it might seem that Home Depot (NYSE:HD) is a stock to avoid. However, I believe that Hone Depot stock will continue to move higher amid economic headwinds. This coverage will discuss the factors to be bullish on HD stock with focus on the benefits of renewed expansionary monetary policy by the Federal Reserve.
It is important to note that Home Depot stock is already in an uptrend. The price of HD has moved higher by 32% in 2019. This is amid concerns of slowdown and trade war.
Clearly, the markets are bullish on the stock after discounting the headwinds. While the stock can witness sideways correction (time correction than price correction), the trend is likely to remain bullish.
Expansionary Monetary Policy Will Help HD Stock
The Federal Reserve has been pursuing renewed expansionary monetary policy and I believe this will be positive for Home Depot. In the latest FOMC meeting, the federal fund rate was cut to 1.75% to 2% with the central bank open to further rate cuts.
I believe that this will help Home Depot in two ways:
First, mortgage rates will drop as federal fund rates decline. This will imply lower debt servicing cost for households and potentially more money in hand for home improvement. This can trigger higher demand for Home Depot products.
Second, individuals will purchase homes to benefit from lower rates and as demand for housing trends higher, the demand for housing and home improvement products will increase.
A very important point to note in the current slowdown is that the manufacturing sector is in a recession. However, consumption spending has remained robust along with consumer confidence remaining high. Walmart (NYSE:WMT) stock is a good indicator of consumption spending and the stock has been trending higher.
The point I am making is that weak GDP growth does not necessarily imply weak demand for housing or housing products. In particular, when the consumption sector has remained strong and the unemployment rate has not increased.
My point is further backed by the fact that for 1H19, the company’s sales per square feet increased along with an increase in average ticket. I expect the positive trend to sustain.
“Homebuyers flocked to lenders with purchase applications, which were up fifteen percent from a year ago and residential construction permits increased twelve percent from a year ago to 1.4 million, the highest level in twelve years. While there was initially a slow response to the overall lower mortgage rate environment this year, it is clear that the housing market is finally improving due to the strong labor market and low mortgage rates.”
Visibility for Sustained Value Creation
I believe Home Depot stock is an attractive dividend stock with current annual payout of $5.44. In addition, the company has been aggressive on share buybacks. I am of the opinion that dividend growth and aggressive buybacks will sustain for HD stock.
To put things into perspective, Home Depot reported operating cash flow of $8.5 billion for 1H19 and free cash flow of $7.2 billion for the same period. This implies an annualized free cash flow of $14 billion. Clearly, there is ample headroom to increase dividends and continue share repurchases.
The ongoing trade war is likely to have a “cost impact” of 2% for Home Depot. However, the company’s suppliers are gradually moving manufacturing out of China to avoid tariffs. Over time, the negative impact on margins should diminish.
Final Words on Home Depot Stock
It is also worth noting that Home Depot will be spending $11.1 billion between 2018 and 2020. The investment will be directed toward existing stores, building online presence and product innovation, among others. The big spending plan is likely to translate into higher sales growth and potentially higher margins.
I remain bullish on Home Depot stock even when the company is in a relatively cyclical industry. While there is a manufacturing sector slowdown, the services sector remains strong in the United States. That will help demand sustain for the company’s products.
In addition, the Federal Reserve has taken appropriate action to ease liquidity and it should benefit consumers through lower mortgage rates. In conclusion, Home Depot stock is attractive and worth considering even after a 32% rally in 2019.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.