Home Depot: Valuation Warnings After Another Stellar Quarter

| About: Home Depot, (HD)

Shares of Home Depot (HD) have seen a very modest correction after yet another very strong earnings report.

Yet I'm concerned about the premium valuation for the shares as the stock is priced for continued good news in the years ahead. I think the current valuation is too high as the recent spike in interest rates could impact the pace or even the entire housing recovery altogether, thereby diminishing the prospects for Home Depot.

I remain cautious, and will not contemplate making an investment in Home Depot at these elevated levels.

Second Quarter Results

Home Depot generated second quarter revenues of $22.52 billion, up 9.5% on the year before. Revenue growth was driven by comparable store sales growth of 10.7%.

Yet overall revenue growth came in slightly lower as the second quarter of 2012 counted 14 working weeks. Combined with the fact that this quarter contained one week less of spring sales, revenues were negatively impacted by $249 million, or 120 basis points.

Total revenues came in significantly ahead of consensus estimates of $21.8 billion.

Net earnings rose by 17.2% to $1.79 billion. As a result of share repurchases, earnings per share growth came in even higher. Earnings per share came in at $1.24, up 22.8% on the year before, and three cents ahead of consensus estimates.

Looking Into The Results..

Besides showing healthy top line growth, Home Depot managed to increase its gross margins by 12 basis points to 34.28% of total sales.

The firm saw nice operating sales leverage, as operating expenses rose by 5.5% in dollar terms, but fell by 78 basis points to 20.88% of total revenues. Adding to this a 4.5% smaller outstanding share base and earnings per share grew by almost 23%.

Home Depot saw a healthy 4.9% increase in the number of transactions while average ticket total rose by 4.3% to $57.39 per sale.

..And The Remainder Of The Year

Based on the solid performance during the first half of fiscal 2013, Home Depot raised its full year sales growth guidance to 4.5%, supported by a 6% increase in comparable store sales.

Full year earnings per share are now seen up approximately 20% to $3.60 per share despite the fact that fiscal year of 2013 has one working week less compared to 2012. The guidance assumes another $2.2 billion of share repurchases in the second half of the year.

Previously the company guided for full year earnings of $3.52 per share and sales growth of 2.8%.


Home Depot ended its second quarter with $3.42 billion in cash and equivalents. The company operates with $12.76 billion in total debt, for a large net debt position of $9.34 billion.

Revenues for the first six months of 2013 came in at $41.65 billion, up 8.5% compared to last year. Net earnings rose by 17.7% to $3.02 billion as diluted earnings per share were up by 23.2% to $2.07 per share.

At this pace, full year revenues are seen around $80 billion with earnings expected around $5 billion.

Trading around $75 per share, the market values Home Depot at $109 billion. Operating assets are valued around 1.4 times annual revenues and 22 times annual earnings.

Home Depot pays a quarterly dividend of $0.39 per share for an annual dividend yield of 2.1%.

Some Historical Perspective

Home Depot has a long-term track record in creating shareholder value for its shareholders. Between 2003 and 2008, shares have traded in a $20-$40 trading range, but have embarked on an aggressive upwards trend ever since.

Shares have set fresh all-time highs of $80 in recent weeks, currently exchanging hands around $75 per share.

Between its fiscal 2009 and 2012, Home Depot has increased its annual revenues by a cumulative 13% to $74.8 billion. Annual earnings rose by an incredible 70% in the meantime to $4.5 billion, while Home Depot retired another 15% of its share base, thereby doubling earnings per share.

Investment Thesis

Home Depot has made tremendous progress in recent years. Yet 2013 is promising to be a stellar year as revenue growth, on the back of a firmly recovering housing market, is picking up pace again.

Still Home Depot has already made a lot of earnings progress over the past years by making its operations more efficient and profitable as it made significant gains in distribution and same store sales growth.

The significant cash flow generation and superior performance compared to troubled Lowe's (NYSE:LOW) means that excess cash flow generation was mainly used to please investors by repurchasing shares at an aggressive pace and paying out dividends. At the current rate, Home Depot is not leveraging down. For the year of 2013, Home Depot will spend almost its entire earnings on share repurchases.

With all signs on green and a current valuation at 22 times earnings, I become really hesitant. Comparable store sales growth is already really high, prospects for operating leverage are diminishing, and the leveraged balance sheet makes it difficult to maintain the pace of share repurchases or other shareholder payouts. This is especially true if economic conditions might unexpectedly worsen.

I looked at Home Depot's prospects back in May after the company reported decent first quarter results. I concluded that shares became too expensive after yet another earnings beat, an opinion I have to reiterate at the moment. While all signs are on green at the moment, I'm hesitant to invest as the valuation multiples, especially on earnings metrics, are increasing.

I remain on the sidelines as the stock continues to price in a lot of good news, a bit too much to my taste. This is especially the case if the recent hike in interest rates could de-rail the housing market recovery going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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