Home Depot Moves From Good To Great

By Stephen D. Simpson, CFA | August 20, 2013 AAA

While it shouldn't really surprise anybody if there's a little volatility or turbulence along the way, it looks like the long-awaited remodeling upturn is firmly in place now. Not only did Home Depot (NYSE:HD) trounce expectations for same-store sales growth, but companies like American Woodmark (Nasdaq: AMWD), RPM (NYSE:RPM), and Stanley Black & Decker (NYSE:SWK) are seeing improved prospects as well. While these shares didn't do much over the last three months and the valuation is not what I'd call “screaming bargain”, I wouldn't step in front of the momentum with my own money.

Another Strong Quarter
I wouldn't call Home Depot's second quarter a blow-out, but it was definitely another strong quarter and further evidence that there is a recovery underway in remodeling and home improvement.

Revenue rose more than 9%, with comp-store growth of nearly 11%. That was well ahead of the 7% Street estimate, and the 11.4% growth in U.S. comps was the strongest result in 14 years – particularly impressive given how much larger the company is today. Comp growth was also very well balanced, as the average ticket was up more than 4% and transactions were up about 5%.

While preparing for the eventual recovery in demand, Home Depot has also been exceptionally diligent about improving store-level and supply chain productivity and efficiency. Although this quarter wasn't a banner example of the progress being made (results were very slightly disappointing relative to expectations), gross margin did improve another 13bp and operating income rose more than 17%.

SEE: Home Improvements That Boost Resale Value

Credit Can Cut Both Ways
While some commentators have opined that rising mortgage rates threaten the housing recovery, I'm not convinced that's a clear and present danger for Home Depot. While it's true that rates are rising, it's also true that banks are expanding their balance sheets and showing more willingness to lend via credit cards and home equity loans. Given Home Depot's exposure to renovation and remodeling, relative to new home construction, I'd call that a net positive for the company, and likely a net positive for rival Lowe's (NYSE:LOW) as well.

Will The Productivity And Efficiency Push Go To Far?
Right now, there's not a lot of fault to find in Home Depot's operations or business plan. Shoppers are coming back to buy more lumber, more appliances, more tools, more paint, and basically more of everything.

On the other hand, I'm not sure how much harder Home Depot can push on its suppliers. Although Home Depot is a huge presence in its market, it's not the only sales channel for companies like Stanley Black & Decker, RPM, and other large suppliers. At some point, pushbacks on pricing, inventory management and so on will become counter-productive, and there's a risk (albeit a slim one) that these suppliers turn more to rivals like Lowe's or the online sales channel (including Amazon (Nasdaq:AMZN)).

The Bottom Line
As I said in the intro, Home Depot certainly isn't cheap by conventional standards, whether that's discounted cash flow, EV/EBITDA, EV/sales or what have you. On the other hand, the company is clearly seeing good sales momentum and the fact that there's still debate about whether the renovation and remodeling markets are back in recovery mode tells me there's more room to run. I still don't see enough potential in Home Depot to invest my own money in the shares, but I wouldn't tell current shareholders to be in any hurry to sell.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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