Wolf’s Corona Discounts: Home Depot – The Home Depot, Inc. (NYSE:HD)

Despite starting later than its competitor Lowe’s (LOW), Home Depot (HD) is actually the biggest home improvement retailer – not just in the US, but in the entire world. With a total store count including Canada and Mexico of 2200 stores, the company is massive. Usually at an incredible premium to fair value (21 times earnings less than a month ago), one wouldn’t expect this company to trade cheaply very often. Indeed, it’s been nearly 10 years since Home depot even approached fair value.

Today, however, thanks to corona, we’re here once again.

Welcome to Home Depot.

Home Depot – What does the Company do?

Home Depot has long been a strong presence in the home improvement market. It sells over 34,000 products through its over 2000 stores across North America. Home Depot is a bit “special” as it doesn’t offer reportable segments in terms of products, per se. Instead, when we look over materials, we find a number of strategic initiatives that the company uses to create a sort of one-stop home improvement shopping experience.

Home Depot operates by:

  • Connecting Home Depot Associates to customer needs with an interconnected experience – stores to online and vice versa.
  • Connect Products and Services to customer needs.
  • Connect Product to shelf, site, and customer.
  • Innovate ongoing value chain/business model.

(Source: 2019 Investor Presentation)

This, together, forms what the company calls its “One Home Depot Experience” into which the company has invested tens of billions of dollars over a number of years.

Home Depot caters to DIY Customers, who purchase products to complete their own projects and installations. These are assisted through associates in stores as well as online resources. Home Depot also offers workshops and clinics to share knowledge and build an emotional connection to its DIY customers – an excellent strategy as I see it, that I wish was applied to a greater degree in Sweden.

(Source: 2019 Investor Presentation)

Home Depot also caters to the Pro’s (Professional Customers), including renovators, remodelers, GCs, Handymen, Property Managers, building service, specialty tradesmen and so forth. The company has created a Pro experience, both online and in-store to cater to these customers. Since 2018, these customers have access to specialized programs and solutions such as inventory management, a dedicated salesforce, custom product offerings, enhanced credit programs, in-store pickups, direct job-site delivered and so forth.

So, in short, Home Depot tries to make certain that all customers, regardless if Pro or DIY, gets a personalized experience and assistance specifically tailored to their needs. While you can argue that many stores try and do this, I think you’d be hard-pressed to find a store that does so more than does Home Depot.

And I’ve only ever been to one Home Depot in my entire life when I visited the US. Still, the best home improvement store experience I’ve ever had.

It’s not as though Home Depot sells in any way revolutionary products. its assortment matches pretty much what you’ll find in any home improvement store of note. Because of this, perhaps it’s necessary to talk sales category specifics, but it may be more relevant to talk, as the company does, about customer groups and how they make shopping a better experience.

Despite being the nation’s largest home improvement store, it’s not as though the opportunity for growth is no longer there. In fact, the potential market share opportunities are amazing.

(Source: 2019 Investor Presentation)

The company wants to target customers who enjoy the three core experiences that Home Depot wants to offer them, regardless of who they are and what they need.

(Source: 2019 Investor Presentation)

The company has been pursuing the current strategy for going-on 2 years at this point, and it’s already starting to show results. Then again, given that the company has spent ~$11B in these areas,

(Source: 2019 Investor Presentation)

it had better show some results.

Another thing that’s relevant when talking about what the company “does” is its employee policies. The interesting thing is that while other stores and companies have a very high turnover rate for employees, over 90% of store leaders begin their careers in Home Depot as hourly associates. This is telling of a company which values its employees and makes them part of the equation.

(Source: 2019 Investor Presentation)

In many European companies, this is a given – but I know this is not the case in some companies abroad, especially in this field. This makes it impressive, and I do believe this is part of what the company “does.” Home Depot measures satisfaction at every point, and the latest investment is driving profitability forward.

With that, let’s move forward to results.

Home Depot – How is the company doing?

(Source: FY19 Presentation)

Selling home improvement supplies when 50% of the nation lives within 10 miles of a Home Depot has its perks. Fiscal 2019 are the latest results we find available, and these numbers show some excellent trends:

  • Comparable sales increase of 3.5% YoY for FY19.
  • EPS increase (diluted) from $9.73/share to $10.25/share.

In terms of operating results, this was a record year for the company and one that shows a long line of excellent improvements over time. Company strategies are showing results – and take a look at recent history.

(Source: SimplySafeDividends)

The only issue is that EPS and sales growth have taken a small hit on an NTM basis. The Earnings trend is solid as steel. Not just that – but the company has also been an active buyer of its own shares, reducing shares outstanding from 1.66B to 1.1B in less than 9 years. RoIC is at a strong 46%, up from 20% in 2011, and the company sports an operating margin of 14% – which is impressive in the light of what it is that the company sells.

The Home Depot has never had much debt – and so it is today as well, coming in at a net debt/EBITDA of 1.81X for NTM. The interest coverage is at 13.19X.

Aside from that, the company has been an extremely generous dividend grower. For the past 20 years, the company has averaged nearly 21% dividend growth per year. While it seems likely this may take a hit this year and/or next year, in the long term I’m not at all worried about this trend and its continuation.

Home Depot has shown in a relatively short amount of time that it can dominate the market – and with its new sales strategy and rollout, I believe it can capture more of a market share, catapulting the company towards further growth.

Home improvement has also been a market that has been extremely slow to change in the face of e-commerce – in the way that rather than Amazon (NASDAQ:AMZN), people still go to, or order from Home Depot. This isn’t surprising, considering Home Depot handles bulky products such as timber/wood, appliances and other items. What I believe will happen is that smaller home improvement stores will, going forward, no longer be able to keep up with larger rivals such as Home Depot. We’re likely to see market consolidation with only a few key players remaining.

Home depot will, no doubt to my mind, be one of those players.

Home Depot – what are the risks?

No business without its risks – and certainly not Home Depot.

  • While Home Depot has been resistant to E-commerce changes, that’s not the same as being unaffected. Many of the company’s orders are now performed out of the store, and only being picked up in the store. In the end, this threatens part of the company’s entire business model of having employees and customer service as part of its core values – online shoppers hardly need the like to the same extent. While many of Home Depot products are ineffective or downright bad to buy online – such as designs for remodels and the like – many of the products sold are still basic items that can just as easily be bought online.
  • Competition in the market is fierce, and margins, like with electronics, are likely to be razor-thin. One of the bigger risks for Home Depot is supply exceeding demand. While I consider Home Depot, together with Lowe’s, to be the “best of the brand,” it’s possible especially during times like these, that there will be an excess of supply.

Risks here are few, however. This reflects Home Depot’s virtually unassailable position in the market in the bigger picture. It has a very strong brand, leading economies of scale, e-commerce and it owns its own real estate, granting it a high degree of control.

There’s not much to dislike about the company.

Home Depot – What’s the valuation?

Which is why this section becomes so very interesting.

(Source: F.A.S.T. Graphs)

We’re talking about a nearly 4%-yielding A-rated conservative company typically trading at over 23 times earnings, now trading at almost ~15 P/E, offering a 6.61% earnings yield at such a valuation. While this may not seem much compared to some of the deals offered today, I hasten to remind you that what you’re buying is essentially the Walmart of home improvement, at a market capitalization of nearly $200B.

This drop in fundamental valuation is completely disconnected from the company’s expected results growth. I thank the corona-crazed market for providing a valuation to Home Depot that we have not seen since the end of the financial recession back in 2010-2011.

Historical results are skewed by the fact that the company was excessively valued going into the dot-com crash, and so it’s barely outperformed the S&P 500 in terms of total returns. However, dividend growth during these years has been excellent – even if the payout ratio is starting to pull to levels where the company may need to slow down.

(Source: F.A.S.T. Graphs)

The company has weathered financial recessions, crises, and upheavals for 32 years without a dividend cut. It’s grown the dividend for 11 years straight, and at a current yield of nearly 3.8%, it’s well above its 5-10 year yield average.

(Source: F.A.S.T. Graphs)

Despite the company’s strong tradition of trading at a high premium, I still want to show you the fair value here, which gives you a 12% CAGR potential annually over 4 years’ time. The market-premium forecast nearly doubles this, but I prefer to take the safe road here.

At a low payout ratio and with an A credit rating, it’s unlikely that even corona will put Home Depot in any sort of serious financial stress. It’s simply a company trading at a huge discount due to a whole host of unknown factors related to a virus that’s currently wreaking havoc in our global economy.

This is, of course, nothing to sneeze at (pardon the pun), but unless you think that corona somehow fundamentally and permanently changes the way this sector operates or how people view the Home Depot, then this company is now at fair value.

For the first time in 10 years.

There’s little realistic discount from fair value to be had here – but that doesn’t matter to me when it comes to this company. Given the company’s strong premium, historically, fair value is more than enough to get me interested here.

Or, to put it another way.

Take my money, Home Depot.

Thesis

Home Depot qualifies on the list I’ve currently put together for this corona crisis. It’s one of the “Ultra-safe” dividend stocks, meaning it combines a BBB+ credit rating or higher, with a relatively low EPS payout ratio and a “Very Safe” dividend rating from Simply Safe Dividends.

In these troubled times, there’s double-digit yield around every corner. With everyone crowing for people to invest in these comparatively unsafe options today, I’m sticking my money in the options I consider safe.

Don’t get me wrong. I’m still a strong investor in real estate. I still love my oil companies, despite the market hating them. However, this is the time to invest in quality companies that otherwise aren’t undervalued.

Historically speaking, such a time comes along every 5-10 years or so – and I do not intend to pass this one up. I’m not a market timer – even though I try to invest with great care, and spread out my investments over time – but I certainly enjoy the timing of this in relation to my currently available and potentially incoming capital.

I’m in great shape to take advantage of this. I hope you are as well.

Home Depot is most certainly one of the companies I’d want to own – and own long term. That, coupled with the current valuation, makes this one a “Buy.”

Thank you for reading.

Stance

Home Depot is a “Buy” for the first time in almost 10 years due to corona-induced undervaluation with a potential 10-20% CAGR in 3-4 years.

Disclosure: I am/we are long LOW, HD. 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: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.

I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.

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