Home Depot: A Strong Buy For Value At $49

| About: Home Depot, (HD)
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By Larry Gellar

Home Depot (NYSE:HD) just announced its first quarter earnings, and the results were not too shabby. The company benefited from an unusually warm spring that encouraged many homeowners to start outdoor projects early, but Home Depot has also done a number of things right to improve its business. One key change has been investment in rapid-deployment centers that ensure items are always in stock while reducing costs. Stores can even wait until the last minute to change orders or shift products based on demand. Home Depot executives also mentioned other tune-ups that investors can be excited about - namely the company's new web site and new in-store services such as a repair center.

Home Depot has undoubtedly benefited from an improving economy as well, but the most important statistics from the latest earnings report are strong regardless. For instance, same-store sales increased by 5.8%, and these were boosted by a 6.1% climb in domestic same-store sales. Despite a relatively uneven economic recovery, the company is seeing consistent growth throughout America. Thirty-eight of 40 of the company's regional markets grew, with two of those being the most depressed housing markets in Florida and California. The broadest measures of profitability also turned out well in this earnings report. Quarterly earnings were up 27% year-over-year to $1.04 billion, and revenue increased by 5.9% to $17.81 billion. For the fiscal year, Home Depot executives are predicting earnings per share of $2.90, caused by a 4.6% increase in revenue, and these results would certainly bode well for the stock price.

Home Depot's quarterly results were clearly boosted by both seasonal items such as lawn products and outdoor project items, and this balance is important for supporting future growth. In fact, based on my projections of future growth for Home Depot, the company appears to be cheaper than I would have otherwise expected. The stock has a price to earnings ratio of 19.77, which is lower than that for similar companies such as Lowe's (NYSE:LOW) (20.69), Lumber Liquidators (NYSE:LL) (28.67) and Builders FirstSource (NASDAQ:BLDR) (negative earnings). Home Depot's other price ratios (price to book of 4.28 and price to sales of 1.08) are also reasonable given this company's ability to keep growing. In fact, with margins like 5.52% net profit, 34.47% gross, 11.70% EBITD, and 9.46% operating, it's clear that this company is already generating solid profitability.

I also recommend investors take a look at Home Depot's question-and-answer session from the earnings report. There, executive vice president of U.S. stores, Marvin Ellison, explained Home Depot's new labor system, which is fairly intriguing. The company is now matching up labor and sales performance to determine which areas of the store need more investment. With that in mind, Home Depot was able to determine that live goods required more spending, and customer service scores in that segment are now improving. Combined with the innovations I have discussed previously, it's not hard to see why Home Depot should be able to keep up with other home improvement companies like Lowe's.

Additionally, as far as the home improvement industry as a whole, Home Depot came up with some interesting ideas about how the building recovery could shape up. Based on Home Depot's statistics (largely indicative of the entire sector), it appears that the larger professional spending is coming back faster than the smaller professional spending and consumer spending. Home Depot's executives speculated that the larger professionals may be having an easier time obtaining credit, and this appears to be a reasonable explanation. In fact, as credit conditions return to normalcy for smaller professionals, Home Depot and similar companies should benefit accordingly.

Of course, Home Depot does have some control over the type of credit that professionals receive, and the company's executives noted that their credit program currently has a 70% approval rate. With the average line of credit amounting to $6,600, this appears to be a prudent way to bring in more business without taking any unnecessary risk. It's also worth noting that Home Depot executives mentioned that smaller professionals tend to be more affected by the economy as they get extra work that trickles down from larger professionals. If that holds true, Home Depot could see even more of a boost from an improving economy than would otherwise be expected.

Meanwhile, there are a number of varying trends in the housing market that will probably even out to a neutral impact for Home Depot. Whereas new home sales did fall by 7.1% in March, numbers for February were revised significantly to show a 7.3% increase for that month. Furthermore, the Case-Shiller home-price index decreased between January and February, but that rate of decline appears to be slowing down if nothing else. Additionally, sales of existing homes improved in January and February but dropped in March. With that in mind, I believe the argument for a Home Depot buy rests on the company's own strengths and larger economic trends rather than what's happening in the housing market.

Home Depot also rewards its shareholders with a 2.3% dividend yield, which is not much but still best of breed for this sector. Based on what I'm seeing in the statement of cash flows, Home Depot is financially strong as well - operating cash inflow was $6.651 billion. With significant amounts of money going toward capital expenditures, stock repurchases and dividends, it's clear that Home Depot is creating value for its shareholders. In fact, I expect that to continue based on the most recent earnings report. I know these earnings did not impress everybody, but they were good enough for me considering Home Depot was trading below $50 at the time of this writing. With its own innovations and ability to ride an economic recovery, investors should see notable profits from Home Depot going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.