Irene And Screening Home Improvement Retailers

by: Erik Dellith

When I first heard that the northeast was going to be hit by a hurricane, I dismissed it. Every now and then, we receive a similar warning, and often the storm avoids the New York metropolitan area. The news indicated that Irene, however, was going to stop by for a visit.

I decided to get some sandbags to put in front of the doors of a business I own. I called the local Home Depot (NYSE:HD) to see if they had any. They were sold out. I called Lowe’s (NYSE:LOW). They, too, were sold out of sand, but they had bags of paver sand left. Not exactly what I wanted, but good enough.

Staring at the pallet of paver sand at the Lowe’s store, I heard a couple of employees talking about how that was all they had left. Lucky me, I was able to grab enough for my doors. I guess I’ll find out soon enough if it worked.

The trip to the store gave me an idea for this week’s stock screen.

Clearly, businesses along the East Coast are going to be impacted by Hurricane Irene. Consider the article by Brian Nichols for some examples.

What about some of the companies that potentially stand to benefit from the hurricane’s aftermath?

I decided to take a quick look at the home improvement retailers. There are seven companies in this industry, so this is going to be quick scan.

Since we are working with such a short list right from the beginning, here is the entire list of companies:

  • Builders FirstSource, Inc. (NASDAQ:BLDR)
  • Calloway's Nursery, Inc. (OTCPK:CLWY)
  • Griffin Land & Nurseries, Inc. (NASDAQ:GRIF)
  • The Home Depot, Inc. (HD)
  • Lumber Liquidators Holdings, Inc. (NYSE:LL)
  • Lowe's Companies, Inc. (LOW)
  • Tractor Supply Company (NASDAQ:TSCO)

Let’s focus on companies that are growing relatively quickly. Specifically, we screen for companies where revenue growth in the most recent quarter is faster than the industry average. This reduces the list to five companies.

Take a moment to briefly consider the companies that don’t make the cut of the screen.

One of the companies that drops out is Texas-based Builders FirstSource. The company, which focuses on building products for residential new construction in the southern and eastern US, is facing a challenging environment, as revenue has slipped recently.

The other company that drops out is Griffin Land & Nurseries. In addition to its landscape nursery business, the company is involved in the management of commercial and industrial properties. According to data from Reuters, Griffin has seen its revenue take a bit of a hit in the most recent quarter, the trailing twelve months, and, on average, over the last five years.

Continuing with the screen, we want to see that some of the top-line growth is making its way to the bottom line. To accomplish this, we screen for companies where EPS growth in the most recent quarter is also faster than the industry norm. Running this screen on Saturday, this requirement leaves us with list of only three companies.

What about the companies that fell out at this stage?

Lumber Liquidators is one company that drops out when we add this focus on earnings to our screen. The company, which is a retailer of hardwood flooring, saw revenue rise 4% in the most recent quarter, yet net income fell.

Lowe’s is the other company that our screen kicks out. The company reduced its forecast for the rest of the year. But, in an effort to boost its stock, the company is undertaking a $5 billion share buyback.

Next, we would like to take valuation into consideration. I recognize that the valuations are a bit tricky, with the considerable market volatility, but we still want something to give us some idea of what is the price. We screen for stocks that have PEG ratios less than 1.1.

There is nothing magical about this number. While deep value investors would prefer to see PEG ratios less than one, less conservative types generally find a PEG slightly higher still reasonable, so we go with 1.1. This leaves us with only Home Depot.

Again, take a moment to consider what we’re losing through the screen.

Texas-based Calloway’s Nursery is a regional garden-center retail chain. It has 19 stores in the Dallas-Fort Worth and Houston areas. According to data from Reuters, no analyst provides estimates of long-term growth, so we can’t calculate a PEG ratio. Yet, if we look at other valuation metrics, we see that this small company (market cap of less than $7 million) has a P/E ratio of about 3.7, well below the industry norm of 19.

Meanwhile, Tractor Supply Company operates farm and ranch stores. The company’s recent quarterly revenue results were shy of expectations, but earnings came in better. Based on analyst expectations for earnings this year ($2.83, according to Reuters) and a long-term EPS growth rate of about 17, the company has a PEG ratio of about 1.23. If we look at next year’s earnings ($3.25), however, the company’s PEG ratio falls to 1.07.

So, this leaves us with the only company that met the growth and valuation criteria defined in our screen: Home Depot.

Home Depot is also the largest player in the retail home improvement arena, with a market cap of about $54 billion. Its share price has lost about 5% over the last three months, while the S&P 500 Index has lost about 10%. When we compare its current price of around $34 to expected earnings this year of $2.36 and a long-term EPS growth rate of 13.2% from Reuters, we get a PEG ratio of 1.09. Using next year’s expected earnings of $2.67 gives a PEG ratio of 0.97, well into value territory. Another factor that is worth noting, HD has a dividend yield of more than 2.9%, comfortably above the industry norm of 2.2%, also based on data from Reuters.

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