Has Home Depot Already Had Its Recovery?

By Stephen D. Simpson, CFA | May 17, 2012 AAA

What a difference a year (or three) makes. While the building superstores Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) have definitely taken their licks from the rotten housing market, these companies are well past the worst of the storm. Not only have Home Depot shares more than doubled from their early 2009 lows, but investors have become optimistic to such an extent that the company is posting substantially better results and still missing some estimates.

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Good Weather a Clear Help
Home Depot reported a nearly 6% revenue growth for its first quarter of fiscal 2012, helped by a 5.8% same-store comp growth. While that's the strongest comp number that Home Depot has posted in eight years, the company's revenue still missed the average Wall Street guess by $100 million, as estimates had been cranking higher for months.

Listening to management talk about the quarter, it doesn't sound like there's much to quibble with in the numbers. Traffic was up a solid 3.9%, helped no doubt by a very mild winter and early spring in most of the country. It was also interesting that pretty much every major category but kitchen was up, while there were solid results in many "professional" categories.

Home Depot also did well on its profits. Gross margin ticked up about 10 basis points, while operating income jumped over 20%. That Home Depot would see strong leverage from better sales activity is hardly surprising, but it's also encouraging to see that various supply chain initiatives seem to be delivering the goods in terms of margin improvement.

Is the Recovery Finally Here?
Investors, analysts, pundits and pretty much everyone with an opinion or vested interest have been trying to figure out whether or not the housing and construction markets have bottomed for quite a while, and there have been plenty of false dawns. Maybe, just maybe, conditions are really starting to improve.

I find it interesting that Home Depot saw good performance in what I'd consider categories that are more weighted towards professionals - building materials, tools, electrical, lighting and so on. A lot of suppliers have been reporting better trends lately, including RPM (NYSE:RPM), and while major tool company Stanley Black & Decker (NYSE:SWK) disappointed with its earnings, there was still underlying organic growth.

I'm certainly aware that the unseasonably warm temperatures may have pulled sales forward and that growth could flag in the following quarters as a result. But when companies like Louisiana-Pacific (NYSE:LPX), Universal Forest Products (Nasdaq:UFPI) and WESCO (NYSE:WCC) all trade near their highs and sport improving analyst estimate trends (significant improvement for the first two), it's pretty clear that Wall Street is keen to believe that this time it's for real.

SEE: Is The Housing Bubble Over?

The Bottom Line
Home Depot seems to have outgrown a lot of mistakes from its past, including ill-fated diversification attempts, over-aggressive store expansions and under-investment in logistics. Moreover, I think Home Depot can benefit from ongoing operational challenges at Sears (Nasdaq:SHLD) and increasing contributions from exclusive and private label brands.

The only problem is that Wall Street and investors are already well aware of all of that. I don't think there's anything wrong per se with Home Depot's valuation today, other than that it already captures most of the growth I expect from this company. While this would be an OK name to consider on a pullback, names like Stanley Black & Decker probably offer more residual leverage to a construction and housing recovery.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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