The Home Depot (HD) - a leading US-based home improvement retailer - seems to have benefited from the improvement of housing market. The Dows Jones would have suffered a lot because of Fiscal cliff and Greece-related issues if HD had not provided support. The Dow was up by 50 points on November 13, 2012. About a third of this rise can be attributed to HD.
Beating the analyst consensus on operational, financial and strategic performance, the company has pushed us to take a bullish stance. Along with many favorable catalysts, we consider its management the key difference maker, as its CEO and CFO have laid the basis for smooth and steady operational performance. This has added much value to the company's stock by raising the price to near historic highs.
What has really come as a wonder to us is its impressive financial performance in Q32012. If compared to its performance in Q32011, the company has witnessed a 4.6% increase in its revenue. Some hints toward effective cost control can also be identified, as the cost of goods sold has gone up by 4.4% thus increasing the gross profit margin from 34% to 35%. We strongly believe that this rise in sales is indicative of the company's sound growth in market share.
This can be of great value if the company manages to capitalize on these cost-control measures. The operating income has gone up by 7.3% while the net income has also seen a 1.4% increase. The company does not seem to be facing liquidity issues because its debt ratio is stagnant at 26%.
If valued from a relative perspective, HD appears quite attractive for many investors. Its multiples are at a discount to those of many competitors. Its 18% EBIT growth is likely to be the highest in the industry.
One interesting fact is that apparently the stock looks overvalued versus its key rival Lowe's (LOW). Although both competitors are quite similar in terms of operations, HD has grabbed higher valuation than LOW. We attribute this difference to a drop in earnings of LOW in the 2nd quarter by 10%. This mainly happened because of lower same store sales. While HD has been able to increase its same store sales by 4.3% this year, LOW has seen a decline in SSS by 0.4% in 2011 and can see a decline by 65 basis points by the end of FY2012. Moreover, HD is more profitable than LOW (HD's net income is 3% more than LOW). Holistically analyzing, we see clear prospects of organic growth in HD with strong capitalization on improving trends and reducing expenses.
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Strategic Horizons and Potential Catalysts:
The Home Depot has managed to grab a buy rating from us mainly because of its strong organic growth despite tight fiscal scenarios. We strongly believe that some catalysts are highly responsible for bringing much of the growth to the company. We also feel that its performance in the future will depend on the impact of those catalysts.
One of the very significant catalysts is the clear boom in the housing market of the United States. Since 2007, this market has shown a deep fall in overall performance and speculations about its probable recovery were quite uncertain. However, this market has started showing some improvement this year. Prices in the housing market have started going up this year. A 5.9% rise has been seen through June as shown in the following graph. This is in addition to a sharp rise in existing home sales as well as building permits.
Still another natural catalyst is the post-Sandy recovery phase. The impact of this hurricane has been quite destructive and it is expected that home repair and development needs will rise in the near future. As the core business of The Home Depot revolves around these needs, we anticipate strong same store sales of the company in the future. However, this would depend a lot on HD's ability to capitalize on the recent changes in market needs.
We feel that there is a high chance that the company would be able to do so. This is because of company's plan to contribute greater cash to existing stores. The company had clear plans of diversifying and expanding to other locations in the U.S. and other countries. However, because of recent business conditions, the company has abandoned expansion nationally and internationally. This has mainly been done to focus more on existing stores.
The Home Depot management has been the leading factor behind its accelerated financial performance. Analysts view it as the leading determinant of future performance. CEO Frank Blake and CFO Carol Tome have laid the key foundation for strong operating performance. Their firm execution of tactical strategies and focus on customer service have helped the company in achieving enhanced results.
The Home Depot is a company with impressive operational performance. Its stock has more upside than the stock of many competitors. The company has a brilliant strategic horizon. We believe that HD will be able to capitalize on many catalysts which would not be the target of many competitors. This would mainly be because of its ability to leverage strong operations and profitability.
Although, it has cancelled its expansion plans, we believe that its focus on existing core by contributing more cash is highly appreciable. Its management has been quite lucrative in the past focusing more on customer centrism and service excellence. We really look forward to some strategic moves from its management in the future, and therefore have a buy rating for HD.