Home Depot: Analysis And Six-Month Price Projection

Aug.20.14 | About: Home Depot, (HD)

Summary

Home Depot recently reported strong second quarter earnings and raised its full-year forecast;

While HD's results surprised the market, they were in line with Home Depot's performance of recent years;

We make a projection for Home Depot's stock price for the period immediately after the full 2014 fiscal year is reported.

Home Depot's Earnings Have Been Rolling Higher

Home Depot (NYSE:HD) reported second quarter earnings on 19 August 2014 that exceeded expectations and cheered investors. Since its performance and results are often seen as a bellwether for the housing market in general, they have repercussions across the retail sector and, indeed, the entire market. Thus, they are of interest to many traders, not just Home Depot shareholders.

Below, we make a projection of the HD stock price for the period after the company reports full-year fiscal 2014 earnings in February. To do that, we have to examine the company's - and the stock's - past performance in some detail. Even if you don't believe in projections, you may find some of the analysis of interest.

Let's see how they did.

Second Quarter Earnings

Home Depot reported $23.8 billion in revenue and $2.1 billion in net earnings for the quarter. The net earnings were 13.5% above a year earlier and revenue was above the $23.6 billion forecast. Net income was $1.52 per share and beat estimates by $0.08.

The company raised its full-year 2014 forecast to $4.52 per share, above its previous forecast of $4.38 per share. That would be a 16.8% increase over 2013 earnings, which in turn were 25.3% above 2012 earnings.

HD also raised its dividend to $0.47, a 21% increase.

Implications

Home Depot's sparkling numbers shook up a market that has been marked by lackluster numbers from Macy's, Walmart and other retailers. Macy's cut its 2014 same-stores sales forecast from a 2.5-3.0 increase to a 1.5-2.0% increase, while Walmart cut its 2014 earnings guidance from $5.10-5.45 per share to $4.90-5.15 per share. These earnings reports shook up the retail sector and made some think that the apparent widespread retail weakness, along with concerns about the housing sector, would extend to Home Depot.

But HD confounded them and not only did not lower its forecast, it raised it. So what is going on with Home Depot, and what does it mean to the market?

Let's Look at HD's Historical Numbers For Context

The second quarter, falling midway through the fiscal year, is a good time to assess the probabilities on how the full fiscal year is going and how, ultimately, it will wind up. Those second quarter numbers are the most recent numbers we have for comparison, so those are what we will use. The economic crisis of 2009 also reversed during Home Depot's second quarter, making it a particularly interesting quarter for comparison for this company.

We'll first take a look at the raw data supplied by Home Depot, then look at what it might mean in terms of Home Depot's possible performance over the next six months. To start out, here are HD's numbers from the second quarters of past years.

Home Depot Second Quarter Earnings Results 2006-2014
Year Earnings per share y-o-y % ∆ Revenue (billions) y-o-y % ∆
2006 $0.82 +9.8 $22.6 +16.7
2007 $0.71 -6.1 $22.2 -1.8
2008 $0.71 -7.8 $21.0 -5.4
2009 $0.66 -7.0 $19.1 -9.1
2010 $0.72 +9.1 $19.4 +1.8
2011 $0.86 +19.4 $20.2 +4.2
2012 $1.01 +17.4 $20.6 +1.7
2013 $1.24 +22.8 $22.5 +9.5
2014 $1.52 +22.6 $23.8 +5.8
Click to enlarge

The earnings reports illustrate that Home Depot reacted poorly to the economic crisis of 2008-2009 and has been recovering since. Given the very slight fall-off in performance in 2014, we have a hint that the critical or inflection point of the post-2009 recovery may have been in 2013, when the year-over-year earnings growth peaked. But that is just a supposition based on too-limited data.

Next, let's compare second-quarter comparable store sales over the same period and see what they tell us.

Home Depot Comp Store Sales, Second Quarter

Year Year-over-year Percent Change
2006 -0.2%
2007 -5.2%
2008 -7.9%
2009 -6.9%
2010 +1.0%
2011 +3.5%
2012 +2.6%
2013 +10.7%
2014 +5.8%
Click to enlarge

In this chart, 2013 again stands out, when the comp store sales peaked. However, the 2014 numbers are still the second best during the entire period, so the company is still executing well. The high 2013 number may simply have been an aberration, the 2014 number is more in line with the trend of the preceding numbers.

By the end of the second quarter, management typically has a pretty good idea how earnings are tracking for the full fiscal year. Next, we look at the forecasts made by management after the second quarter and how they stacked up after the figures for the full fiscal year were in. We'll compress this to just the last six years for simplicity.

Forecasts Made By Management After the Second Quarter For that Full Fiscal Year
Year Earnings Forecast Result Revenue Forecast Result
2008 $1.80 $1.34 -5.0 -7.8
2009 $1.34 to $1.43 $1.55 -9.0 -7.2
2010 $1.90 $2.01 +2.6 +2.8
2011 $2.34 $2.47 +2.5 +3.5
2012 $2.95 $3.00 +4.6 +6.2
2013 $3.60 $3.76 +4.5 +5.4
2014 $4.52 ? +4.8 ?
Click to enlarge

The takeaway from this chart is that Home Depot, at least recently, has habitually under-promised and over-delivered with its second-quarter earnings forecasts made for the full fiscal year. It did that for every single second quarter earnings and revenue forecast from 2009-2013. The 2008 forecast was a tricky one because the economy was just about to slide into recession and thus is an outlier. The economic slowdown that year apparently took management by surprise in the degree of its severity. They learned their lesson, though, and have not over-promised since.

Now, we have some good data with which to work. The Home Depot earnings forecasts were off with some regularity, so let's see exactly how consistently.

Percent Earnings and Revenue Forecasts Missed
Year % Earnings Forecast Missed % Revenue Forecast Missed
2009 8.4 1.8
2010 5.8 0.2
2011 5.6 1.0
2012 1.7 1.6
2013 4.4 0.9
Click to enlarge

Several things jump out from these numbers. First, they show the consistency over the past five fiscal years of Home Depot underestimating their earnings and revenue forecasts. Second, management has been much closer to the actual result in its revenue forecasts than it has been in its revenue forecasts. Third, HD management lost part of their earnings "cushion" in 2012, but made adjustments and got it back almost in full for their 2013 forecast. Thus, presumably they are back on track with their forecasting style after that minor blip and have returned to doing their regular thing again - consistently underestimating their earnings in their public forecasts.

The data in the chart also lead to the following calculations:

  • The average annual earnings result was +5.2% above the forecast
  • The average annual revenue result was +1.1% above the forecast


Apparently, the company is better at forecasting revenue than earnings, cutting it a lot closer. Or, perhaps they just want a bigger cushion on the earnings number rather than the revenue one because casual new-readers focus on the earnings number more.

The earnings reports delivered each February after the completion of the full fiscal year naturally affect the stock price in a big way. To get an idea of how the market has valued the stock in recent years, let's take a look at both the full-year earnings numbers and the stock price on the immediately following 1 March. This date is always a few days after the earnings report and gives traders a chance to digest it after the initial knee-jerk reaction.

Full Year Fiscal Earnings and Subsequent Stock Price
Fiscal Year Net Earnings ($B) Earnings per Share ($) Stock Price on 1 March ($) Price/earnings ratio
2006 5.8 2.79 39.45 14.14
2007 4.4 2.37 26.55 11.20
2008 2.3 1.34 20.89 15.59
2009 2.7 1.57 31.43 20.02
2010 3.3 2.01 36.76 18.29
2011 3.9 2.47 47.46 19.21
2012 4.5 3.00 69.03 23.01
2013 5.4 3.76 82.03 21.82
Click to enlarge

Now, we have enough information to make a projection.

Stock Price Projection

A projection is not a prediction. A projection is an extrapolation of known data into the future, whereas a prediction could be based upon any number of things or, actually, nothing at all. This is a projection, not a prediction, and it will vary depending upon how you vary the inputs. We have shown our inputs above.

Projections seldom turn out to be accurate predictions, but they do provide a structure for thinking about possible outcomes. Nothing would make us happier for shareholders than for this projection to fall well short of the mark.

The company's current earnings forecast for fiscal year 2014 is $4.52/share. This is a 20.2% increase above the 2013 fiscal year earnings. Adding an additional 5.2%, or $0.20, gives an adjusted earnings projected result of $4.72 for the 2014 fiscal year.

The company's revenue forecast for fiscal 2014 is +4.8%. This would give total revenue of $3.78 billion over 2013, or $82.6 billion in revenue for 2014. Adding an additional 1.1% to that gives projected 2014 revenue of $83.45 billion.

Projecting a stock price introduces one more unknown variable - the market multiple. Obviously, we cannot know what that is in advance, and that will determine the exact stock price at any point in time. However, as shown above, Home Depot's multiple for the past five years, since the recovery from the 2009 financial crisis, has hovered between 18 and 23. So, using projected annual earnings of $4.72, we get the following projections for that range of multiples.

Price Projections for Home Depot Stock
Market Multiple Home Depot Stock Price
18 $84.96
19 $89.68
20 $94.40
21 $99.12
22 $103.84
23 $108.56
24 $113.28
Click to enlarge

Choosing among these figures requires a judgment as the strength of the economy, and particularly of the housing market which drives so much demand to Home Depot. Investors look ahead, as the figures from previous years show, with the multiple tending to lead events. Calling a market turn in advance requires an element of luck. As shown by the data above, Home Depot's multiple is very sensitive to the economy, dropping well before the financial crisis and recovering before it was even completely over.

The economic recovery has been slow - too slow for some - but steady over the past several years, with the exception of weather-related events. There is a lot of pessimism that has not been borne out by the statistics, but it also is undeniable that the recovery has been proceeding at a slower pace than previous recoveries.

The most recent data shows that U.S. housing starts jumped 15.7% in July 2014 over the previous month. That has to be good news for Home Depot - all those builders and new homeowners will be hurrying down to buy water hoses and shovels and light fixtures and building materials. While the July figure could be a temporary blip, it still falls squarely within the middle of Home Depot's fiscal year and suggests strength for the remainder of the warm weather months. Thus, we err on the side of optimism, not pessimism.

A multiple under 19 would suggest economic weakness, especially in housing data, that simply isn't there, at least not yet. A jump of the multiple over 23 would suggest that the economy is roaring ahead or that Home Depot is having a super year, but GDP data for the year so far is very weak and the latest HD earnings release was good, but relatively normal. It beat expectations, but the 2013 numbers were also very good. Extreme outcomes for the remainder of the year seem unlikely.

Thus, choosing the midpoint of the range of likely market multiples from the above table, 21, that leaves a projected stock price of $99.12 after Home Depot reports its fiscal earnings in February 2014. Given the company's recent excellent execution, though, that projection may turn out to be low if traders get excited about the stock and the company's prospects and/or the economy and housing gain strength as the recent figures suggest. If interest rates shoot up or bad economic news hits, the actual stock price is likely to be lower.

Obviously, that precise price is unlikely to be seen at that time except by chance. But it likely to be reasonably close.

The primary risk factors for this projection are: Home Depot not meeting its forecast in the same way as usual; and/or the economy either greatly strengthening or weakening in the interim, changing market multiples across the board, including Home Depot's. This could, for instance, be the result of a long-anticipated spike in interest rates, though there is no sign of that happening as of this writing.

Conclusion

Based upon Home Depot's recent past performance, the broadest projection of stock prices for Home Depot after it reports its full fiscal year earnings in February 2015 is $84.96-$113.28, with a projected stock price in the $99-100 area the likeliest result.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.