By Brian Sozzi
Home Depot's (NYSE:HD) $2 billion note issuance triggered flashbacks to the go-go days of 2007-2008, when the use of cheap debt funding was running rampant as a means to juice shareholder returns. From 2008 to 2010, Home Depot was in de-leveraging mode, cutting its LTD/Equity ratio to 46% in 2010 from the cycle peak of 64% in 2007. The focus by CEO Frank Blake and his team was on returning Home Depot to a leadership position in the home improvement marketplace and improving operations at the store and back office levels in the pursuit of driving above consensus earnings growth.
Customer service issues will always seem to follow Home Depot around, no matter the internal measurement scores, but for the most part management has delivered an impressive earnings story to its shareholder base amidst a very turbulent recovery in the housing market. Keep in mind Home Depot's top line is being fueled by existing homeowners doing minor upgrades, rather than a boom in new building activity and professional flippers fixing up an entire block of homes bought at a steep haircut in price.
The announcement earlier in the week signals a transition in the Home Depot investment thesis from organic growth underlying the stock's performance to a compelling total return profile on the stock (earnings growth, 2.8% dividend yield, cash returned by way of repurchases). All we can hope for is that the announcement is not 2007 once again; when Home Depot's LTD/Equity ratio eventually hit its peak in 4Q07, the stock went onto to shed 43% of its value up until the March 13, 2009 intraday trading low. Obviously, the circumstances are different now as considerable speculative excess has been wiped clean from the system, but the impending spike in foreclosures does loom large as a threat to the ever so modest recovery in housing evidenced late last year.
Net/net, it's tough to take management to task on its decision to tap the debt markets, as rates remain attractive for long-term issuances. A cash buffer, should the economy soften and cause management to pull back on its share repurchase plans, has been built with the utilization of rather low cost financing. Though Home Depot is paying a touch more in terms of interest on the latest issuances as compared to those in September 2010, we deem the rates attractive for a retailer battling housing related headwinds and an evolution as to how business is conducted. We have raised our EPS forecasts for FY11 and FY12 assuming Home Depot acts upon $3.5 billion in repurchases this year and then stays along that course with its remaining $6.6 billion or so of availability.
Note: Management reiterated its FY11 sales and EPS targets, encouraging in light of recent housing market indications (renewed pressure on home values in particular).
* $500 million senior notes due September 15, 2020 at a 3.95% yield
* $500 million senior notes due September 15, 2040 at a 5.40% yield
* $1 billion senior notes due April 1, 2021 at a 4.4% yield
* $1 billion senior notes due April 1, 2041 at a 5.95% yield
Who Else Is On Tap to Pull a Home Depot?
Characteristics of Share Repo or Div Increase Announcers Lying in the Weeds:
* Lagging stock price relative to peer group this year or a stock price well off the 52-week high of late April 2010.
* High cash and equivalents balance as a percentage of total balance sheet assets.
* Being pushed by shareholders to use cash more productively.
* Stock is trading at a discount to historical trading multiples.
* Other catalysts (cash cow, special situations).
* Generated $5.2 billion in operating cash flow alone last year.
* Has $7 billion remaining under its $10 billion share repurchase program announced in November 2007. However, I think the company will be announcing shortly a sale of all, or part, of its $6.1 billion credit card receivables portfolio. With the proceeds, I would not be surprised to see it enter a new repurchase plan and hike the dividend.
* The stock has languished, down 20% since the start of the year. The market is concerned about the company's margin direction as it expands into a greater number of food categories and aggressively remodels its U.S. store base and pushes the model for the first time into Canada.
* Debt to equity ratio only 50%.
* Good credit ratings.
* Stock has stalled this year after a nice run up in 2010.
* The company, in my view, has been extra-conservative regarding the use of its balance sheet. The company had $5.4 billion in cash and equivalents at the end of the recent quarter for a strong 21% of total assets. $894 million was left on a $1.1 billion prior share repurchase plan, but again with pressure from shareholders, I can see a new plan and a dividend increase (payout ratio a rather low 25%; dividend yield 1%).
* Good credit ratings.
Urban Outfitters (NASDAQ:URBN)
Normally, share repurchases and dividends do not go hand in hand with specialty apparel retailers. Managements like to use the cash to fund new store openings globally, website development, and technology investments (inventory planning tools, etc.). However, I believe there could be a special situation here given Urban, while still being one of the stronger square footage growth stories in retail, looks to improve the total return profile of the stock as it enters its next phase in its life cycle (more consistent earnings growth rather than off the charts strong).
As of right now, the company has 10 million shares left (about $290 million applying current share price) under a prior authorization and no dividend plan, but a stock price down 24% since the disappointing March 8 earnings report. Cash and equivalents as a percentage of total assets are a high 25%, and I think the company could support a stronger share repurchase plan and a dividend payout even as it expands both domestically and into Europe and Asia. My sense is that it is feeling some degree of heat to put the cash to work outside of funding future growth.
CVS Corp. (NYSE:CVS)
Stock is down 8.3% since the April 2010 high, I think on continued concerns regarding the Caremark business. But the company is poised to generate over $4 billion in free cash flow this year. I think there could be a case where given the stock's disappointing showing in the market, the company announces a new repo plan later this year ($2 billion share repurchase plan is currently in play) on top of the remaining availability under the older plan. Price to earnings multiple a mere 10.6x next year's estimates, and the stock has underperformed peer Walgreen (WAG) over the last 12 months.