Why Home Depot Will Continue To Outperform

| About: Home Depot, (HD)
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The Home Depot, Inc. (HD), which is a major player in the home improvement market in the US, has seen good growth in the past year on the back of a bull run in the housing market. This has pushed company's share prices upwards. Further, there are some lingering fears that the growth of sales in the housing sector may not be sustainable. However, as we shall see below, the improvement in housing sector is likely to continue, and HD stands in a much better position than its smaller rival Lowe's (LOW), and therefore will likely benefit more from any improvement in the housing sector. Considered together, these facts make a strong case for HD's continued growth.

Good news from the housing market

The housing market has had much to cheer about it 2013, with sales of new homes growing steadily between July and September as mortgage rates fell. Further, sales of existing homes have also risen by 6% YoY in October. Housing prices are rising as well, and are currently up 12.5% over 2012. Companies like Home Depot, which are heavily dependent on the housing sector for sales of its home improvement products, have naturally benefited. HD's transactions in the last quarter rose 4%, driving its revenue up by 7.4% to $17.5 billion.

This has been reflected in HD's stock prices. HD's shares are currently trading at 21.3 times the expected earnings of the current fiscal year. This makes the stock appear relatively expensive, and some have wondered if rival Lowe's may be a better option.

The growth is likely to continue

The good news is that the housing market is not likely to slow down in 2014. This is because, firstly, data shows that in 2013, there were more people (36% to be exact) in the 18-31 age group living with their parents or in room sharing arrangements than even 2009, which is regarded as the worst year of the recession. The economy has been steadily improving, and the easy passage of the budget should provide the economy with the needed confidence to continue growing. This suggests that more people will seek to move out of their parental or room sharing accommodations to own a home of their own.

HD currently holds 18.7% of the market share, which will help it cash in on this growth. Further, the company has been seeking to improve growth by introducing new "smart-home" products like WiFi enabled locks, which are costlier but which are expected to drive growth as more people seek to modernize their homes or simply replace worn out material.

Why Lowe's isn't the right option

Though Lowe's is also expected to benefit from this growth, it suffers from some disadvantages. Firstly, it has a smaller market share of 15.2%. It also lags behind HD in terms of total stores (1,825 to HD's 2,300 stores). Home Depot's same store sales grew 7.4% as compared to Lowe's 6.2%. Home Depot has a profit margin of 4.7% compared to Lowe's 4%. HD has a debt to equity ratio of 0.47 and $4.9 billion cash on hand compared to Lowe's debt to equity ratio of 0.8 and only $1.2 billion cash. Finally, HD's dividend yield stands at 1.98%, compared to Lowe's 1.54%.

The investor's decision

The above analysis suggests that growth in the housing market is likely to continue, benefiting both HD and Lowe's. However, HD has outperformed Lowe's by quite a margin, and possesses a better balance sheet. These, when considered together, suggest that while HD may be currently expensive, the company's growth prospects for 2014 justify the price to some extent. Hence, while investors who already have the company in their portfolio would do well to "hold", new investors seeking a company with decent growth potential may consider buying into HD's stock.

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