I spoke well of Home Depot (HD) and the home building sector about two years ago, as what I viewed as the Trump bull market was young. At the time, the builders Toll Brothers (TOL) and D.R. Horton (DHI) were around $29 and HD was around $140. As the home builder sector (ITB) has faded - to my loss of prior profits - I traded out of the builders. But I have kept my HD and plan to do so for years. Here's one big picture reason, via an analogy.
Our family was once taken on a day trip out of London by a guide with a Mercedes. We visited Little Gidding, by a historic small country church, where a gift shop and house had been built with American money. An elderly married couple tended the property. Jeremy, our guide, charmed the old lady into serving tea and small cakes she had baked on the outside patio, overlooking a bucolic English countryside scene of farms, fences, hills, great-smelling air, and so on. Jeremy leaned back, fully content, and exclaimed: "This is England."
In response, 18 years later, I will say about Home Depot: this is America.
Gizmos, even world-changing ones such as the iPhone, come and go, but houses (and condos, apartments, etc.) always remain. And they get old and need renovation and, often, expansion, and HD is the #1 source for help with that sort of thing.
There's another reason I think this way. It also goes back to Jeremy, who got around town and the sticks with help from an oversized book that showed detailed street maps of everywhere... metro London of the 1950s. He explained that England never changed (by 2018 it finally has). America, he went on to say, was in contrast always building and rebuilding, always expanding or trying to do so, always changing roadways, etc. So our street maps always needed updating.
That's the related reason I think of HD as a foundational stock for a US-based investor. I believe it has managed to achieve a share of mind that is special in a country where growth and regrowth are essential parts of our mindset.
A strange thing is just how could an industry sector that sells commodities: appliances, lumber, paper towels, John Deere (DE) lawn equipment, and so on produce a duopoly of retailers focusing on this segment? I don't know, but we are where we are, and HD is the leader in its sector.
Yahoo! Finance shows HD at 4 cents per share 37 years ago; it closed Tuesday at $179. That's a 25.5% CAGR over the past 37 years, not including dividends. In contrast, Apple (AAPL) has gone from about 33 cents per share to $192, an 18.8% CAGR.
Is HD the single best-performing large stock of any major company that was public in 1981?
In this article, I am looking past the housing slowdown with regard to HD, because I think it's become an iconic brand for which...
The best is yet to come (part 1)
Based on HD's past performance, I'm carrying the 12-month forward EPS at $10 or so, meaning Q4 FY2018 through Q3 FY 2019. That puts HD around 18X EPS. Given that this is GAAP, it is approximately equal to my forward estimate for GAAP EPS for the S&P 500 (SPY).
I think that HD deserves a significant, substantial premium.
HD has now achieved the improbable. By out-competing Lowe's (LOW) and forcing it to retrench, HD looks to be in the process of moving from the larger member of a duopoly more toward... well, not a monopoly, but something more dominant. How has it done this? By executing on e-commerce, store-based productivity improvements, and an ongoing major 5-year plan to enhance its warehouse and logistics system. This will allow it to face off well against Amazon (AMZN) within HD's field, and as discussed below, challenge it.
The more HD conference calls I listen to, the more perceive a no-fast- talk, just-get-it-done, results-oriented corporate culture.
To me, deciding whether a stock is a permanent hold, that's what matters more than the Fed-driven, politician-driven (etc.) cycles that all businesses and all industries go through.
Let's discuss specifically why I think there's no reason for HD's growth to end any time soon.
The best is yet to come (part 2)
I suspect that HD's conference call and solid earnings report show that it is on its way to grow in ways that are not "in" its stock price. Here's one thing from the conference call that I'm focusing on:
And then as a follow-up, just on home décor, I've seen the catalog this year, is there any - are you leaning into that category in any way different than what you did last year, is there any build there or is it more of the same?
As we outlined in our investor conference at the end of last year, we said we were going to lean in to home decor and we've been doing that with the catalog and in online, this is an online and direct play for us and we're seeing nice results, the customers engaging with The Home Depot in the home related decor categories and we'll continue that through the next year, certainly.
Remember that HD is enhancing many parts of its operations, from its warehouse/logistics set-up to car and truck-based home/worksite delivery. It's doing this from a position of strength.
The Pros are leading growth for now; HD is increasingly "owning" that sector in contrast to a shrinking LOW. That's an immense opportunity with vertical and horizontal expansion possibilities, including exclusive brands at good price points for the Pros and with good margins for HD.
Now think of the even larger retail customer segment, which HD calls the do-it-yourselfer, or DIY. For now, that's what they/we are. But AMZN began with books and CDs, and look at its product list now (plus AWS/Alexa).
Is there any reason that HD will stop with home decor (more on that below)? I think there is none. Rather, if I'm everyone from a faltering Bed Bath & Beyond (BBBY) to a stronger Best Buy (BBY), or an Office Depot (ODP) with a $3+ stock price, I'm worried that HD will begin to add this... and that... and something else... to its product list - and promote it more prominently. That's one large opportunity that HD has, and it's growing e-commerce at a 28% yoy rate with nearly half of those orders being picked up in store. Add proprietary home delivery, from HD's own inventory centers, think of the margin opportunities while it grows. In other words, where AMZN has begun to go, bypassing UPS (UPS) and FedEx (FDX), that's where HD is and where it can do more.
The best is yet to come (part 3); a trip down memory lane... from two months ago
In early September, I picked up on an update from the company and wrote an article titled How Home Depot Is Moving Toward Tech To Drive Alpha. It is behind a PRO firewall now, but the article drew on a Seeking Alpha transcript which:
One part of that article may tell the tale of why I think HD may be under-appreciated:
The company has hired AI/machine learning experts, and numerous data scientists along with other software experts. Per the CFO:
"In the IT organization alone, this year we are hiring 1,500 people into our IT shop to help advance technology throughout our company."
This is a significant hiring spree in a single year for a chain of home improvement stores.
Mr. Menear observed that HD's customers usually initiate their purchase online, and that e-commerce customers spend more heavily than traditional store visitors.
HD is also a tech/AI company.
And it is gearing up to be able to sell more things; quoting their CFO from the same September Q&A:
Our goal is to be the fastest and most efficient deliverer of home improvement products. And on the efficiency side, this is a big deal for us. We're spending $1.2 billion (over several years). And when we built the financial model to show that we would get an adequate return on that investment and our IRR hurdle is 12%, we built that model solely on transportation savings as well as cube utilization. (We) didn't rely on sales to support that investment (but) we wouldn't be doing this if we didn't think we get some (extra) sales off this as well.
When HD talks about efficient delivering of home improvement products, some of that is very large and bulky, not AMZN's forte, but there is partial overlap in product size and category. And now it is suddenly selling... lots of stuff.
A look at "home decor"
HD's home decor dropdown menu allows one to explore its many things for sale, including:
- kitchenware, such as cake pans, spice racks, dinnerware sets, and kitchen carts
- living room furniture, including numerous coordinated furniture for the entire room, TV stands, and throw pillows, area rugs, and curtains
- home offices, including offices for one person and for two; hand-painted and other artwork
- Bedroom Inspiration: this includes mattresses and bed frames, and bedding; and nightstands and dressers.
HD is selling mattresses and bedding (and bed frames). Interesting...
It is not what it was not long ago. And it's doing so in a cost-effective, quiet manner. I like the financial reward:risk ratio here, and this sort of effort calls for patience from investors as I see it.
Before wrapping up, I want to ask:
Can HD match or even outcompete AMZN in the home?
This could get interesting. To again quote HD's CFO: "Our goal is to be the fastest and most efficient deliverer of home improvement products. And on the efficiency side, this is a big deal for us. "
HD is changing its image, mostly digitally, but not just there. It sells lawn mowers; it sells large packs of paper towels. It sells candles.
Here's an HD advantage. Its many stores and website allow anyone wanting, say, new kitchen cabinets to be offered a "deal" on, say, knife holders, plates, and other things one might want to buy for the kitchen. What about coffee makers? The web page shows 152 choices. What about coffee? That web page shows 6876 results. How much of a step is it to go from selling coffee and coffee makers to selling the creamer or milk for the coffee? Since HD sells lots and lots of refrigerators, why not sell that which goes into the fridge, i.e. food? Since HD sells scads of washing machines, why shouldn't it have a "deal" to induce you to get your laundry detergent from HD? That category has 153 results.
And so on.
I am thinking of HD as wanting to join AMZN and Walmart (WMT) as the major general merchandise retailers in North America, though for HD, "general" would for now exclude perishable foods and clothing, except for things such as painter's coveralls (32 results).
That's for now.
But with HD selling closet organizers (163 results), why not sell sneakers, sweaters, and T-shirts?
Hmmm... it does sell T-shirts (834 results). Can sweaters and sneakers then be far behind? Stay tuned...
It looks to me as though HD is trying to expand into an omni-channel general merchandiser for that which we put into our homes, outside the homes, and eventually on our bodies. And to some degree, that which we drink and eat.
That's a basic reason why I like it with a patient approach, even though the risks are significant, and I'm not adding to HD on this sell-off due to the cyclical risks and the fact that HD rose more than 10X from its Great Recession lows to its recent highs.
Is HD ignoring the housing market?
In addition to all the macro risks of investing in HD or any stock, I did get the sense from HD's responses to analysts on the conference call that it might be a tad too optimistic about trends in US housing. The Fed, Congress and the Obama White House all went to great lengths to reinflate housing prices. Now there is evidence of deceleration or worse in both new and existing home sales by volume and by price. While HD sells to the reno market much more than the new home market, the two do correlate. Right now, as of Wednesday morning, ETrade is showing analysts projecting $112 B in revenues for FY 2019 and EPS of $10.25. I would not be surprised if the Fed's tightening program and macroeconomic factors caused HD to at least not do its usual beating of expectations, and possibly come up short.
Many other risks exist, including enhanced competition from LOW, AMZN and others; and lack of success in moving the home decor merchandise.
Technically, HD is not looking too hot, except on longer-term charts where the structural uptrend becomes apparent. That's no guarantee of the future, however. BBBY used to be in a secular uptrend, too.
Summary and concluding points
My view is that HD is where America now thinks first when it wishes to make changes to its existing housing stock, and that it is building aggressively to expand on that status with good prospects for profitable growth. I wish LOW well and have made good money in the past 1-2 years, but LOW now has operational challenges. HD is moving to lay the foundations for future growth via investment in store productivity, distribution capabilities, e-commerce, and a much broader product range that the era of e-commerce allows to be done without an excessive investment.
HD now may represent a Buffett-type dominant stock, with a wider moat that is priced into the stock. It is moving merchandise that it can move again and again and has numerous opportunities to expand vertically and horizontally, as well as - when and if it wishes - geographically beyond North America. Its high operating profit margins provide a major competitive advantage and have been achieved over decades of hard work, and I think will not falter easily to competition, just cyclically. While HD carries a good deal of debt, the Q&A made clear that HD and the analysts think its balance sheet could be leveraged more, with more aggressive buybacks if the stock got too cheap.
Thus I posit that HD is a keeper indefinitely. However, macro trends in the US and global economy, the Fed's hawkish actions, and the technicals in HD and home builder stocks keep me from adding around $180, where it trades Wednesday morning as I submit this pre-market.
Cycles come and go, and down cycles eventually work to the benefit of the strongest competitors. HD is building on its strengths to expand and take market share from fading retailers as well as, I think, from the biggest and the best such as AMZN and WMT. At approximately a market multiple, HD looks to yours truly to be a good choice for long-term alpha. Retailing is tough, though, and short and long-term downside risks need to be considered.
Thanks for reading and sharing any thoughts you wish to contribute.
Disclosure: I am/we are long HD, DE, FDX. 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: Not investment advice. I am not an investment adviser.