Home Depot Earnings Preview: When Does The 'Return Of Capital' Story Become A Growth Story ?

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 |  About: Home Depot, Inc. (HD)
by: Brian Gilmartin, CFA

Summary

$25 bl in free-cash-flow returned to shareholders in 4 years.

Average rate of y/y revenue growth since Jan '08 has been 1%.

Some technicians think stock is forming a top.

Home Depot (NYSE:HD) reports their fiscal first quarter before the opening bell on Tuesday morning, May 20th, 2014.

Analyst consensus is looking for $0.99 in earnings per share (NYSEARCA:EPS) on $19.95 billion in revenue, for expected year-over-year growth of 4% and 19% respectively.

Both the consensus EPS and revenue estimates for q1 '15 have declined slightly since the February '14 earnings reports.

In the February '14 fiscal 4th quarter, HD comp's were +4.4% and the US stores comp'ed at +4.9%, probably weather-aided duet to demand for shovels, salt, and snow-removal equipment in the Midwest and Northeasters US.

HD management guided to +4.6% comp's for this coming year, and to $5 billion in share repo's, versus the $8.5 bl last year.

If you look at Home Depot over the long cycles, from the late 1990's through the collapse of the large-cap growth stocks in the early 2000's, (HD fell from $70 to $20 per share) and then the 2008 Recession, the big catalyst for HD's shares the last 3 years has been the $10 - $11 billion in share repurchases, and the retirement of about 200 million shares or roughly 14% - 15% of HD's fully diluted shares outstanding.

During that time the share price has risen from the low $30's as of August, 2011 to its near $80 trading range today.

As a glaring example of what I'm talking about, using our internal spreadsheet, the "average" rate of y/y revenue growth from the January, 2008 quarter through the February, 2014 quarter is 1%, while the "average" EPS growth rate is 11%, with most of that coming in the last 3 - 4 years.

Over the last 4 years, HD has returned $25 billion to shareholders in the form of dividends and stock repurchases, most of it share repurchases, beginning in late 2010.

Much of this excess cash-flow has been driven by lack of any real store growth. Between February, 2013 and February, 2014, HD opened a whopping 7 new stores.

And square footage, which was 238 million as of October, 2008, is now 236 million as of February, 2014, so HD's total square footage has actually shrunk the last 6 years, but the fact is HD management is using the current square footage far more productively.

Technically, a number of technicians I trust think HD could be topping out. On a chart that could be a trading range too, as HS as traded between $82.50 and $73.96 the last 12 months. The stock hasn't made a decisive new high in that time.

HD's valuation remains mixed: EPS growth for calendar 2014 is expected at 18%, with an 18(x) p.e currently, so on a PEG basis the stock is cheap. The average expected EPS growth for HD over the next 3 years given current consensus is 15%, versus the expectation of 4% revenue growth.

At 14(x) cash-flow and 17(x) free-cash-flow, the cash-flow valuations aren't as compelling as the PEG metric.

Another interesting metric is HD's dividend payout: the expected share repo may have been reduced to $5 bl since HD is now paying out 40% of its EPS in the form of the dividend.

For me personally as an investor, the dividend, the dividend payout and the dividend strategy always communicates important information in terms of management's expected growth and investment opportunities.

With such little store growth, and mid-single-digit top-line revenue growth HD might be communicating via the dividend strategy and the smaller share repo program, that the retailer is nearing the final innings of the "cash-cow" stage. When a retailer starts paying out 50% of its EPS in the form of a dividend, or put another way, is retaining just 50% of its earnings, then it is making a significant statement about its investment opportunities and growth prospects.

There is an old saying by Jim Cramer, (whom individual and institutional investors either love (or don't love)) which he repeats frequently on CNBC, and that is "you can't shrink yourself to prosperity" and in fact HD has done that, as well as IBM, mostly by shrinking shareholders equity via share repurchases and not growing the top-line very much.

I was listening to some of the guys on FastMoney this week talking about the "financial engineering" around IBM with pejorative connotations, and the fact is Home Depot as done the exact same thing IBM has, and done it well too.

To Jim Cramer's point and ultimately for HD and companies which repo shares over long periods of time to drive EPS growth, the question remains, "What is the next step to drive revenue growth ?" and for HD that remains the unknown.

We are long HD and have been for several years. We trimmed some of our position last spring and summer but still hold the bulk of our shares.

A break below the early February '14 low of $73.96 and on heavy volume, and the next stop could be under $60 per share. The 200 week moving average for HD is $53.50 per share. The May, 2000, high tick during the large-cap growth blow-off was $70 per share.

Here is an interview I did with CNBC's Courtney Reagan last May '13 on HD. She is a good reporter, but I think some of the math or calculus around reduced capex, lower store growth resulting in higher free-cash-flow and thus more share repo's may not have been easily grasped, given the questions. (It is really analyst geekdom, so I cant blame her.)

When does HD's "return of capital" story become a growth story once again ?

Inquiring minds want to know.

Here and here are some of our earlier Home Depot articles, and the theme remains pretty consistent. Over the last 5 - 6 years HD has improved everything but revenue and store growth.

Disclosure: I am long HD, IBM. 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.