Home Depot: Estimated Fair Value Of $243 Per Share

Summary

• Home Depot has maintained its market leading positions with a high level of customer loyalty.
• It reported a growing revenue but declining profit in the first quarter of 2020, due to COVID-19 related expenses.
• It has strong balance sheet with good liquidity position.
• It could be worth $243 per share.

Home Depot (NYSE:HD) has always been considered a good stock for long-term income investors, with consecutive dividend payments since 1987. In the past decade, Home Depot has outperformed the S&P 500 by more than three times. As Home Depot has recently reached its all-time high, with the highest EBITDA of all time, we do not think the stock is cheap now.

A market-leading position with a high level of customer loyalty

In the home improvement retailing industry, Home Depot and Lowe's (LOW) are still the two biggest giants, accounting for nearly 60% of the U.S. market share in the fourth quarter of 2019. Home Depot had the highest foot-traffic share of 34.3%, while Lowe's ranked second with a 24.8% foot-traffic share. HomeGoods and Menards had the third and fourth positions with 8.7% and 7.1% market share, respectively.

Source: Placer.ai

Home Depot currently has more than 2,290 stores throughout the U.S. It serves two types of customers, Do-It-Yourself (DIY) customers and Professional Customers (PRO). DIY customers are mainly homeowners who purchase home improvement products to fix and maintain their homes themselves. PRO customers are professional renovators, general contractors, and property managers.

Because PRO customers buy home improvement products at Home Depot for their jobs, they often visit the stores more frequently and spend much more than other regular retail customers. Although PRO customers account for roughly 3% of the company's total customers, they generate around 40% of the company's total revenue. As a result, Home Depot has focused on servicing the PRO customers at its best. The company helps its customers finance their projects with its private-label credit card (PLCC) products, offering a 365-day return policy and extending payment terms. In the fiscal year 2019, Home Depot has 4.8 million new credit accounts, bringing the number of total active holders to around 16.7 million.

Because of the excellent customer service, Home Depot scores the highest in customer loyalty level, with 2.6 visits per quarter. Menards and Lowe's ranked second and third, with 2.48 visits and 2.29 visits per quarter, respectively.

Source: Placer.ai

Growing revenue but declining profit because of COVID-19 expenses

In the first quarter of 2020, Home Depot has managed to grow its revenue despite the global COVID-19 crisis. Its sales increased by 7.1% year-over-year to $28.26 billion, while the gross profit rose by 6.74% to $9.62 billion. The company experienced positive comparable sales in 11 of its 14 merchandising departments. Only home improvement products such as Kitchen and Bath, Millwork and Flooring, which required in-home installation, had negative comparable sales in the first quarter. While the comp transaction declined by 4%, its average comp ticket jumped by 11.1%, thanks to the substantial increase in basket size. In the recent first quarter, Home Depot experienced 6.4% comp sales growth, including 9.3% in February, 7.1% in March, and 4.2% in April.

While the sales and gross profit has grown, its operating income came in at $3.28 billion, 8.8% lower than its operating income in the first quarter last year. The lower operating income was driven by higher Selling, General & Administrative Expenses (SG&A). Its SG&A jumped by 18.7% year-over-year to $5.8 billion, resulting from the company's employee benefits' expansion as part of its COVID-19 response. Diluted EPS was $2.08, 8.4% lower than Q1 2019 EPS of $2.27.

Strong balance sheet with good liquidity

Home Depot has quite a strong balance sheet with lots of financial flexibility. As of May 2020, it had nearly $8.7 billion in cash, $35.82 billion in long-term debt, and $5 billion in long-term operating lease liabilities. The high cash level in the first quarter resulted from its recent $5 billion senior long-term note issuances, with interest rates ranging from 2.5% to 3.35%, and due between 2027 to 2050.

To enhance its liquidity position, Home Depot has doubled commercial paper programs from $3 billion to $6 billion. It also has a backup credit facility of total $6.5 billion, including a 364-day $3.5 billion due in March 2021, a five-year $2 billion due in December 2022, and a 364-day $1 billion credit facility due in December 2020. As a consequence, besides its $8.7 billion cash, Home Depot can potentially tap into an additional $12.5 billion in the commercial program and backup credit facility if necessary.

Compared to Lowe's, Home Depot has maintained a consistently low financial leverage over time.

Source: Ycharts

In the past five years, Home Depot's Debt/EBITDA has stayed in the small range between 1.4x to 1.67x, while Lowe's leverage ratio has been much higher, fluctuating between 1.87x to 3x. We expect its EBITDA to decline more than 10%, from $18.2 billion in 2019 to $16.25 billion, equivalent to its 5-year average EBITDA. Thus, its 2020 financial debt/EBITDA could be growing to more than 2.2x, still lower than Lowe's leverage level.

It could be worth around $243 per share

Due to its market-leading position, Home Depot has had a higher valuation than Lowe's most of the time in the past ten years. At the current trading price, Home Depot's EV/EBITDA is nearly 16.9x, while Lowe's is trading at 20% lower, at only 13.7x EBITDA.

Source: Ycharts

Home Depot could experience a short-term decline in the 2020 operating performance. However, we expect the revenue, cash flow and EBITDA will be on the rise again from 2021. In the past decade, Home Depot has grown its EBITDA at the compounded annual growth rate of 10%. With a similar 10% yearly EBITDA growth, Home Depot's EBITDA could reach $21.6 billion by 2023. If we apply a 5-year average EV/EBITDA valuation of 13.5x, its enterprise value should be $292 billion. If we assume the net debt stays around $30 billion at that time, its market capitalization should be $262 billion. With the total shares outstanding of 1.076 billion, Home Depot could be worth roughly $243 per share.

Conclusions

With the market-leading positions and lots of liquidity, we expect Home Depot could sustain its operating performance and grow its cash flow and EBITDA in the next several years. However, Home Depot has reached a new high in the stock market, trading at the highest EBITDA multiple of all time. We estimate its fair value would be $243 per share.

Analyst’s Disclosure: I/we 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.