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Shares of Home Depot (HD) are trading with large gains of up to 3.5% in Tuesday's trading session. The home improvement specialty retailer announced its first-quarter results before the market open, accompanied by an increase of its full-year outlook.

The strong results sent shares to fresh all time highs, approaching $80 per share. At these elevated levels, shares have become too expensive to my taste.

First-Quarter Results

Home Depot generated first-quarter revenue of $19.12 billion, up 7.4% on the year before. Adjusting for the fact that the fourth quarter of 2012 had 14 working weeks, first-quarter sales are inflated by $574 million.

Factoring in these adjustments, comparable-store sales rose by 4.3%, driven by a robust growth rate of 4.8% in the U.S. Revenues came in far ahead of consensus estimates of $18.69 billion.

The company reported net earnings of $1.23 billion, up 18% from last year's earnings of $1.03 billion. As a result of its share repurchase programs, diluted earnings per share rose by 22.1% to $0.83. Earnings comfortably beat consensus estimates of $0.77 per share.

CEO and Chairman Frank Blake commented on the first quarter developments, "In the first quarter, we saw less favorable weather compared to last year, but we continue to see benefits from a recovering housing market that drove a stronger-than-expected start to the year for our business."

Looking Through The Earnings Report

Gross profits for Home Deport came in 34.9% of total revenues, up 20 basis points on the year before. Margin expansion was driven by acquisitions, which reported higher gross margins than the overall group.

Home Depot saw strong operating leverage as operating expenses came in at 24.0%, a whopping 120 basis points below last year's levels. Consequently, operating profits came in at 10.9% of total revenues, up 170 basis points on the year before, and are approaching Home Depot's long-term target of 12%.

Strong revenue growth was driven mainly by greater spending per visit. On average, consumers spend 5.0% more per transaction, for an average ticket price of $57.24. The number of transactions rose by 2.5% to 337.1 million. As the number of stores being operated was essentially unchanged from last year, average weekly store sales advanced by 7.5% to $658,000.

A Strong Start Bodes Well For The Remainder Of The Year

As a result of the solid first-quarter results, Home Depot is raising its full-year targets. Full-year sales are expected to increase by some 2.8%, driven by comparable-store sales growth rates of approximately 4.0%.

Diluted earnings per share are expected to increase by some 17% to $3.52 per share. Note that results are especially impressive, considering that 2013 has one entire working week less than the fiscal year of 2012. The earnings per share guidance assumes that Home Depot will repurchase another $4.4 billion of its shares in the coming three quarters. The new guidance is in line with analysts projections of $3.54 per share.

Previously, Home Depot guided for full-year earnings of $3.37 per share, based upon a total revenue increase of 2.0%.

Valuation

Home Depot ended its first quarter with $4.34 billion in cash and equivalents. The company operates with $12.79 billion in short- and long-term debt, for a net debt position of roughly $8.45 billion.

Home Depot generated full-year revenue of $74.8 billion for 2012, up 6.2% on the year before. Net earnings came in at $4.53 billion, up 16.8% on the year before.

Factoring in the 3% gains in Tuesday's trading session, the market values Home Depot around $117.5 billion. This values the firm at 1.5 times 2013's expected annual revenue of $76.9 billion, and 22-23 times full-year earnings of $3.52 per share.

Home Depot currently pays a quarterly dividend of $0.39 per share, for an annual dividend yield of 2.0%.

Some Historical Perspective

Long-term holders of Home Depot have seen decent returns, especially in recent years. Shares have traded in a $20-$40 trading range between 2003 and 2011, but broke out toward the upside at the end of 2011, currently approaching levels of $80 per share.

Home Depot was well-positioned to take advantage of the housing recovery, a strategy that is now paying off. Rather than expanding its store base, Home Depot has demonstrated strong comparable sales growth, thereby generating a lot of cash, which was used for share repurchases and divided hikes. This provided a double whammy for shareholders.

Between 2009 and 2012, Home Depot has grown its annual revenue by a cumulative 13% to $74.7 billion, with growth rates accelerating in the second part of the period. Spectacular was the 70% improvement in earnings, coming in at $4.53 billion. Earnings per share growth was even more impressive, after Home Depot decreased it shareholder base a by little over 10% over the past four years.

Investment Thesis

Home Depot reported solid first-quarter results, as the positive effects of a continued housing recovery outweighed the poor weather during the quarter.

Shares lost roughly half their value, falling from $40 in 2007 to lows of $20 during the crisis in 2009. The housing crisis resulted in steep revenue declines for Home Depot, especially in hardest hit areas like Florida, and California. Given the solid recovery in these hardest-hit areas, Home Depot is well positioned to benefit from the general housing recovery. Investors will learn more about the state of the recovery when Lowe's (LOW) will open its books before the market open on Wednesday.

Yet Home Depot has made tremendous progress in recent years, pushing revenue forward, and even more so profitability, at its existing locations. Improved centralized distribution capabilities and impressive same-store growth rates results have resulted in significant operating leverage, thereby boosting profits.

The strong cash flow generation in the meantime, combined with limited capital expenditure requirements, has allowed the company to boost payouts to shareholders by share repurchases and dividend hikes.

Operational improvements and a solid financial strategy have boosted he valuation, as shares have more than tripled from levels back in 2009. Home Depot has only recently started to fire on all its cylinders, supported by the housing recovery, which has resulted in an out performance of the company's pro segment.

Weather continues to play an important role, especially in the short run. Comparable growth rates came in at plus 4.6% in February, followed by a negative rate of 3.5% in March, which was driven by poor weather. This was followed by impressive same-store growth rates of 9.9% in April, as the weather improved, driving demand for garden products.

The solid cash flows allowed Home Depot to buy back $2.1 billion worth of its own shares during the quarter, repurchasing its shares at a pace of 7.2% per annum. This large buyback activity partially explains the run up in shares in recent months, as the company expects to slow down the pace of repurchases to a cumulative $4.4 billion in the three remaining quarters of the year.

Back in February, when I took a look at the company's prospects following the news of its capital allocation strategy, I was amazed by the premium valuation of its shares In recent years, profit growth was driven by margin expansion, not necessarily revenue growth. Only now, revenue growth is accelerating again, on the back of the housing recovery.

While operational excellence, and a shareholder-friendly strategy is to be applauded, a valuation at 23 times 2013's expected annual earnings is a bit too rich for me. I remain on the sidelines based upon a valuation call.

Source: Home Depot - Shares Become Too Expensive After Yet Another Earnings Beat