Is Home Depot Still an Outperform?

With shares of The Home Depot (NYSE:HD) trading at around $77.88, is HD an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Home Depot has been performing well. Is this momentum sustainable?

The Goldman Sachs Group (NYSE:GS) stated that investors may have to wait until Q2 results before seeing any meaningful acceleration in home improvement retailers. Goldman Sachs has set an $81 price target for Home Depot and rated it neutral due to premium valuation and near-peak margins. Oppenheimer has rated Home Depot and Lowe’s Companies Inc. (NYSE:LOW) an Outperform.

As far as home prices go, single-family homes have increased the most since 2006. Experts in the industry feel that homes are still undervalued by approximately 7 percent. This would mean more room to run for home improvement retailers. The industry has performed well year-to-date, but the consensus on the street is that the industry’s potential has been inhibited by colder-than-normal temperatures in the northeast.

On a company-specific basis, Home Depot has managed to steadily reduce operating expenses since 2009. It has also managed to increase cash flow as of late. Another example of good management is that Home Depot has only added 21 stores over the past five years. This might not seem like a positive, but it shows that management has acted responsibly considering an unsure economic environment. It has also lead to strong margins.

The company culture at Home Depot is good. Employees have rated their employer a 3.2 of 5, and 61 percent of employees would recommend the company to a friend. These aren’t great numbers, but they’re above average. What’s more impressive is that 80 percent of employees approve of CEO Frank Blake, which indicates quality leadership.

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The chart below compares fundamentals for Home Depot and Lowe’s.

HD LOW
Trailing P/E 25.96 25.58
Forward P/E 18.90 17.09
Profit Margin 6.07% 3.88%
ROE 25.42% 12.89%
Operating Cash Flow 6.98B 3.76B
Dividend Yield 2.10% 1.50%
Short Position 2.70% 1.20%

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Strong

Home Depot has outperformed the market as well as Lowe’s for every time frame listed below (excluding the past month for Lowe’s). Home Depot also offers a higher yield than Lowe’s at 2.10 percent. Lowe’s currently yields 1.50 percent.

1 Month Year-To-Date 1 Year 3 Year
HD 7.82% 26.61% 63.41% 139.6%
LOW 14.51% 22.75% 51.87% 76.33%

At $77.88, Home Depot is trading above its averages.

50-Day SMA 73.10
200-Day SMA 67.31

E = Equity to Debt Ratio Is Normal

The debt-to-equity ratio for Home Depot is close to the industry average of 0.50.

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Debt-To-Equity Cash Long-Term Debt
HD 0.61 2.52B 10.81B
LOW 0.66 666.00M 9.08B

E = Earnings Are Strong

Earnings have steadily increased on an annual basis. It should also be noted that Home Depot managed to deliver profits in a very difficult environment in 2008/2009 (however, the stock didn’t hold up well at that time). As far as revenue goes, there has been impressive growth over the past two years.

Fiscal Year 2009 2010 2011 2012 2013
Revenue ($) in billions 71.29 66.18 68.00 70.40 74.75
Diluted EPS ($) 1.34 1.57 2.01 2.47 3.00

When we look at the last quarter on a year-over-year basis, we see significant improvements in revenue and earnings.

Quarter Jan. 31, 2012 Apr. 30, 2012 Jul. 31, 2012 Oct. 31, 2012 Jan. 31, 2013
Revenue ($) in billions 16.01 17.81 20.57 18.13 18.25
Diluted EPS ($) 0.5036 0.68 1.01 0.63 0.6839

Now let’s take a look at the next page for the Trends and Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

T = Trends Support the Industry

Rising home prices lead to increased consumer spending, which favors the industry. Eventually, rates will increase and demand will fall. The current environment isn’t likely to be sustainable over the long haul, but there is likely to be a lot of time before any significant changes take place.

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Conclusion

Home Depot has strong margins, impressive cash flow, good management, and trends support the industry. Analysts also like the stock: 18 Buy, 11 Hold, 1 Sell.

Home Depot remains an OUTPERFORM.

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All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions.

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