Home Depot: Solid Defensive Play For Dividend Investors

| About: Home Depot, (HD)

Summary

Home Depot derives most of its revenue from the United States and is an ideal hedge against Brexit-related market volatility.

While Home Depot has a lot of long-term debt, it is not at an unsustainable level and will not prevent a possible dividend increase.

We believe that the company is likely to pay dividends for the foreseeable future and could provide Dividend Investors with a solid dividend yield during the near term market volatility.

Analysis

Nice Brexit Hedge. In the aftermath of Brexit and the subsequent onset of heavy market volatility, many dividend-focused investors are seeking stocks that won't be directly impacted by the Leave vote and will still provide a solid dividend yield.

One such stock is Home Depot (NYSE:HD). With just 13% of its stores located outside the United States and a 2.13% dividend yield, Home Depot is just what the doctor ordered for investors seeking to ride out the Brexit storm.

Indeed, Home Depot reported revenues and earnings that beat the Wall Street consensus handily during its fiscal first quarter. What's more, the company raised its guidance for the rest of fiscal 2016, saying that revenues were now expected to rise by 6.3% and that it expected to earn $6.27 for the year.

Dividend Impact and Outlook. Investors who buy $10,000 worth of Home Depot stock can expect approximately $213 per year in passive income. Home Depot's shares have traded down modestly in the year to date, falling by 0.9% on disappointment that comparable store sales during its fiscal first quarter weren't stronger and that its forward guidance isn't more robust. The consensus estimate is for Home Depot's sales to rise by nearly 17% this year.

We believe that the stock's weakness is an opportunity for investors to buy the stock cheaply. In our view, Home Depot has the financial capacity to continue paying dividends for the foreseeable future. To wit:

Home Depot's annual divided in just $2.76/share - that's less than the $6.27 that the company expects to earn for fiscal 2016, meaning that it actually has room to raise its dividend from its current income (rather than previously retained earnings) if it wishes to.

Indeed, while Home Depot's earnings didn't grow by as much as Wall Street might have liked, the fact remains that its earnings grew by 9% in its first quarter - a faster rate than the 4.1% growth rate in consumer spending on furniture and home furnishings and the 1.7% rise in existing home sales during the comparable period.

Meanwhile, Home Depot has fairly solid short-term financial strength indicators. Specifically, both its Quick and Working Capital ratios are in-line with the average for its industry, which means that the company can readily meet its short-term liabilities.

At the same time, Home Depot's operating cash flow has been strong, rising from $1.4 Billion in the 3rd quarter of fiscal 2015 to $3.6 Billion in its most recent quarter. This has enabled Home Depot to pay-out approximately $2.36 Billion in dividends over the past 3 quarters.

That said, investors should keep an eye on Home Depot's leverage. Both its long-term debt-to-equity and leverage ratios are well above the levels for companies in its industry. Similar to McDonald's (NYSE:MCD), which we discussed last week, Home Depot has engaged in a fairly heavy stock buyback program, repurchasing over $34 Billion worth of its shares while racking up around $21 Billion of long-term debt.

This leveraged recapitalization could ultimately hurt the company if its growth stalls and earnings turn to losses. However, the ratio of Home Depot's Long-Term Debt to its annual EBITDA (currently 1.56) is still well below the 2.0x level considered 'safe.' In fact, credit ratings agency Fitch has affirmed Home Depot's long-term Issuer Default Rating of 'A' and given the company's rating a stable outlook. In short, while it's definitely worth paying attention to Home Depot's debt levels, it's not yet at a level where investors should be concerned.

Going forward, there's little reason to expect Home Depot to reduce the pace of its dividend payments. It's expected to see revenue growth of 13.5% next year and 14% growth on average over the next five years. Meanwhile, on top of the $6.27/share in earnings it expects for fiscal 2016, analysts expect it to report profits of $7.16/share in fiscal 2017, a 14% improvement. If anything, Investors can probably expect another 10-cent per share increase in its dividend by 2017 - something it's done in each of the last 3 years.

Conclusion

All things considered, we believe that Home Depot presents an excellent opportunity for investors to buy a Brexit-hedged dividend play.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HD over 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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.