Home Depot (NYSE:HD) is an industry leader that has advanced well beyond its highs of 2007 and is up over 40% over the past 12 months. Many investors are kicking themselves for not buying this stock long ago. Has it become too expensive get in on this symbol of the housing recovery? Absolutely not. Home Depot is still a buy, it is set to thrive on builders' resurgence and also from home owners renovating the aging inventory in the United States. Within its industry Home Depot is best suited to benefit from the increased demand as it is by far the largest company in the home improvement space at $105.5B market cap versus the next largest in Lowe's (NYSE:LOW) at $42.3B. Additionally the company is an industry favorite because it efficiently distributes cash to shareholders. Home Depot recently increased its distribution to a quarterly dividend of $0.39 a 34% increase. Most importantly, the company has a perfect 8-1-0 record against the last nine earnings estimates.
Bullish on Market, Led by Housing
I expect Home Depot to pull a monster Q2 as the home improvement retailer stands to greatly benefit from strength in housing, pent-up demand for renovations, and as an industry leader it stands to benefit the most in its sector and is deserving of a higher multiple. These warehouse-style stores sell an assortment of building materials, home improvement and lawn and garden products and provide a number of services as well such as equipment rental. Housing is widely credited leading the market last year, especially in the early part of the year. While prospects continue to impress investors, many are shying away from this space, the Yahoo! Finance chart of SPDR S&P Home Builders ETF (NYSEARCA:XHB) and the SPDR S&P 500 ETF (NYSEARCA:SPY) below clearly indicates the recent weakness and that the XHB has recently underperformed the SPY:
Movement out of the XHB is fear based and many are calling for a market correction and maneuvering to defensive sectors like the SPDR Health Care ETF (NYSEARCA:XLV), up 18.5% YTD; or even rotating back into bonds. Investors should look at any weakness in the likes of Home Depot, however, as an opportunity to buy. The stock will enjoy continued growth as the top brand for builders and renovators. Bears would be better off buying macroeconomic protection through buying the Short term VIX Futures ETF (NYSEARCA:VXX), because selling Home Depot during what is panning out to be a brilliant quarter for the company is not contrarian, it is simply not based on company performance. Short positions on Home Depot will be painful for the foreseeable future.
The average age of American homes is finally leveling off now that home builders are adding new homes again but new homes is not the only response to this aging inventory. As these homes are getting older and after several years of weak new homes numbers, home owners in general are needing to fix and maintain their assets. The direct beneficiary is a retailer like Home Depot, which is simply better positioned to harness the resurgence in renovation as well as necessary, bare-minimum home maintenance. The evidence is everywhere; just drive by any Home Depot this weekend and you can see for yourself the parking lots are full and not just of builders' flat bed trucks, but the Scion and Honda that are paying up for anything from grass seed to tile.
Homeowners are finally experiencing an opportunity to sell their homes for a reasonable amount against their cost bases from nearly a decade ago. There is high demand for home improvement as a means to fetch the best price for existing homes. Additionally, new home owners of previously vacant properties or foreclosures face major repair and maintenance. The excitement at Home Depot stands to continue as home owners are drawn to make the updates they have wanted and the repairs they have been putting off. The process builds on itself just as car owners continue to reduce asset age back to normal levels, which results from many factors but not least of which is also enticing home owners to update their assets or step into new homes. That is: few want to be the last on the block with an old car or a beat up house. Americans desire personalization and as they watch their neighbors update, pride builds and they are enticed to act on their own behalf. Aside from builders consistently adding to new homes and supporting Home Depot through their own demand, renovating is in vogue this season and a driving force for this home improvement company
Home Depot is an industry leader, and just as Alcoa (NYSE:AA) will benefit from Automotive and Aerospace demand growth, Home Depot will benefit from the Housing recovery. One would expect a mega brand like Home Depot, symbol of housing recovery, and industry leader to carry an expensive price-to-earnings ratio but there is real value yet to be uncovered in this company; the ratio is just barely higher than Lowe's. It is clear that this company has too many positive considerations to have a multiple near Lowe's. Home Depot is up more than 15% year to date, despite this impressive advance, it can still be considered undervalued. With a relatively low trailing twelve month price-to-earnings multiple of 23.7. According to Scottrade Research, the price-to-earnings multiple for the home improvement industry is 23.6 TTM, which includes underperformer, Lowe's with a ratio of 23.1 and two other favorites, Tractor Supply Co. (NASDAQ:TSCO) and Lumber Liquidator Holdings (NYSE:LL) with ratios of 28.5 and 40.5 respectively.
When comparing Home Depot to top competitors, it is difficult to ignore its advantage in return on equity, which has averaged 18.2% over the last five years, second in its industry only to Tractor Supply Co. This much smaller company ($7.5B Mkt Cap) is an excellent company yet it cannot match Home Depot in terms of value or yield. Tractor Supply Co. only has a 0.74% dividend yield compared with Home Depot's increased dividend yield to 2.2%. The multiple should be higher for Home Depot and the fact that it is not makes it a buy at this level, not to mention at any weakness. An appropriate multiple for this company would be closer to 26.5 TTM, given the environment and industry peers. At that multiple, the price would be around $79.50 more than an 11.3% increase from today's opening price of $71.40. However, one should also consider earnings growth in May. The consensus earnings estimate is $0.76, a 16.9% increase over last year's results for the same period. Of course, it is quite possible that analysts have underestimated Home Depot's role in the American housing recovery. Look for another earnings beat for Home Depot and positive market response.
Invesment or Trade?
Both a bullish trade and a nice entry point are available for Home Depot. Owning this stock long term is an excellent way to benefit from the housing and financial recovery in the United States while earning income with the stock's consistent dividend, currently yielding 2.2%. As mentioned, the company is undervalued so an investor would also benefit from both capital appreciation and income. Trading this stock through earnings is a great play as well. The use of options to leverage the next announcement event could be very profitable with a strike price near or lower than the target above, and benefit from another earnings beat. Home Depot makes a habit out of beating estimates. It has beat or met expectations in each of the last nine quarters. It is reasonable to expect the growth in earnings trend to continue and very likely strengthen through the May earnings report.
Disclosure: I am long HD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a professional advisor; my interpretations of the market are independent and should not be construed as investment advice