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The Home Depot, Inc (NYSE:HD) is the largest home improvement retailer in the world, with annual sales in excess of $70 billion. The stores average 128,000 square feet of retail space. At the end of 2011, the company operated 2,252 stores in the USA, Canada, China and Mexico. The stock is up 30% during the last 5 years compared to the 8% decline in the broader markets. The company has a market capitalization of $77 billion and offers a dividend yield in 2.2%. In this article, I will perform valuation analysis to determine the fair value and 12-month price target.

I started my analysis by reviewing the historical growth rates for HD. These are shown in the table that follows:

Growth Rates

10 Year

5 Year

1 Year

Revenue

2%

-5%

4%

Income

1%

-8%

16%

EPS

5%

-2%

23%

Book Value

3%

-1%

0%

The past 5 years have been tough for HD and the broader home improvement industry due to the recent recession. The revenue, income, EPS and book value have all experienced negative growth during this time period. Things have improved significantly during the last financial year, with revenue up 4% leading to an EPS gain of 26%. However, the book value was flat ,and this is negative in my opinion.

Going forward, I project an EPS growth rate of 15% aided by recovery in the housing market and improving employment trends. The industry itself is estimated to grow at a 14% clip over the long term.

Coming to profitability, the company has improved its gross margins and largely maintained its operating and net margins over the last 10 years. The returns on equity, invested capital and assets are all strong in my opinion. The company's recent performance indicates improving fundamentals. The table that follows presents the profitability and operational metrics.


Profitability & Operations

10 Year

5 Year

1 Year

TTM

Gross Margin

30%

27%

34%

34%

Operating Margin

9%

8%

9%

9%

Net Margin

6%

5%

6%

6%

Return on Invested Capital

15%

11%

14%

14%

Return on Equity

19%

17%

21%

21%

Return on Assets

10%

8%

10%

10%

Valuation:

Valuation analysis was performed using relative valuation. The multiple used in the analysis was developed using historical analysis of the company's multiples. Additionally, the multiples and operational characteristics of its primary competitor, Lowe's Companies (NYSE:LOW), were considered. A comparison between HD and LOW is shown below.

Symbol

P/E

P/S

D/E

ROA

ROI

LOW

21.84

0.76

43%

5.5%

7%

HD

20.64

1.11

60%

9.63%

13%

The table below shows the valuation analysis results.

Valuation

HD

Jan 14 Proj EPS

$3.14

EPS Growth Rate

15%

Future EPS (5 Yr)

$4.73

Expected P/E

18

Price 5 Yrs Out

$85.16

Unlevered Beta

0.86

D/E

60%

Current Tax Rate

35%

Levered Beta

1.20

Risk Free Rate

2%

Risk Premium

6.00%

Cost of Equity

8.8%

Fair Value

$57.01

Current Price

$51.10

% Overvalued

-12%

As shown in the table above, HD currently trades at a modest discount to fair value. Including dividends, the stock is expected to deliver relatively stable returns of 15% from current levels. I would look to open a position in HD on pullbacks.

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.

Source: Home Depot: This Home Improvement Store Is Cheap