Streetwise for Sunday, October 21, 2018
Given the devastation the 2018 hurricane season has wrought, this might be a good time to look at Home Depot (HD), a company I have never written about, as a potential research candidate.
Home Depot has consistently exceeded earnings estimates. Furthermore, the company’s share price is up 7.5 percent year-to-date, driven by strong performances in the first and second quarters of 2018 and an increase in housing prices.
For the first half of this year the company chalked up revenues of $55.41 billion, a 6.6 percent growth from the $52 billion in the first half of 2017. Growth was driven by the adoption of a new accounting standard that contributed $66 million, along with positive same-store sales growth of 6.2 percent and the addition of four new stores in the last four quarters.
Same-store sales growth was driven by an increase in comparable customer transactions of 0.9 percent and growth in the comparable average sales ticket of 5.3 percent.
Home Depot has had adjusted earnings per share of $5.13 in the first half of 2018, a 30.9 percent increase from the $3.92 per share in the first half of 2017. That growth was the result increased revenues, expansion of net margin and share repurchases.
Net margin improved from 9 percent to 10.7 percent due to an increase in both gross margin and a lower effective tax rate. That was partially offset by a higher SG&A (selling, general, and administrative) expense number.
Management expects 2018 revenue to rise 7 percent with same-store sales growth of 5.3 percent and the opening of three new stores. Note, that guidance includes an extra week of operations in 2018.
Home Depot plans on becoming the most efficient deliverer of home improvement products. To that end it has committed $1.2 billion, based on a financial model with an internal rate of return hurdle of 12 percent. The model depends solely on transportation savings as well as increased utilization store space. There is no reliance on sales to support that investment.
The result will be a faster and more cost-effective delivery both to work sites and general retail customers, with a store-based workforce that will be increasingly focused on shoppers. The result, a bonus of extra sales on top of that 12 percent IRR.
The expectation is that Home Depot will see an increase in pre-tax profits of about 1 percent, due to margin improvement. In other words, a potential long-term increase in margins from a simplification of and enhancement to the supply chain.
In addition to increased efficiency, Home Depot is delving heavily into e-commerce to better serve both its Pro and retail customers. On the Pro side, HD is building on its capability to address different segments of its Pro contractors with a more personalized digital experience. The company plans to launch a pilot soon, with a full business-to-business website coming next fiscal year.
Yet, a degree of caution is called for. The company’s debt-to-asset ratio has gone from 22 percent in 2010 to 61 percent in early 2018, before declining to its current 55 percent.
The persistent rise in balance sheet leverage poses some risk. Yet, the increase in balance sheet leverage has correlated with the increase in share price. Specifically, the company’s total debt balance has more than doubled from $10 billion in early 2013 to a current $25.5 billion.
Furthermore, current liabilities have increased from $10 billion five years ago to more than $18 billion, an 80 percent increase, whereas total assets have increased 15 percent during the same period: At the same time, dividends paid to shareholders has doubled.
The current Street consensus is revenues of $108.3 billion, a growth of 7.3 percent from $100.9 billion in 2017. Earnings per share are expected to increase 28.2 percent to $9.56.
The intrinsic value of the shares using a free cash flow to the firm model is $198. My earnings estimate for fiscal 2018 is $9.60 and $10.20 for 2019, with a 12-month projected share price of $$205 for a 10 percent capital gain. There is also a 2.15 percent dividend yield.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.