Thursday, November 15, 2012

A Retailer to Play the Housing Market

Thanks to the recent improvement in the residential housing market, Home Depot (NYSE:HD) reported an impressive Q3. Along with the results, its shares reached its 52-week high. Home Depot has increased from $30.58 in August to $63.38, delivering to shareholders a 200% gain within just 3 months. Should investors get on the ride? Is the stock already expensive compared to what the market is expecting for the business?
Home Depot, incorporated in 1978, is a biggest home improvement retailer globally, offering shoppers a variety of building materials and home improvement products and services, with 30,000 to 40,000 products in a typical Home Depot store during the year. It classifies shoppers into three groups, including Do-It-Yourself, Do-It-For-Me, and Professional Customers. The business has 4 main product groups with somehow similar revenue contribution. The two groups that have biggest contribution were plumbing electrical and kitchen (30.5% of total sales), and hardware and seasonal (29.5% of total sales). In the last 3 years, Home Depot has performed well with an increase in average ticket, weekly sales per store, and comparable sales. 

No of customer transactions (millions)
Average ticket
Weekly sales per store ('000)
Comp sales
Source: Home Depot 10K
Indeed, 2010 and 2011 is where we see the improvement of Home Depot’s operation. In 2011, its average ticket and average weekly sales per operating store grew 2.6% and 3.4%, respectively. 
In the third quarter of 2012, its sales were $18.1 billion, a year-over-year growth of 4.6%. Its EPS for the quarter was $0.63, 5% higher than the same period last year. It is good to see improvement in the operating figures. Its average ticket grew 2.9% to $54.55 with 331 million customer transactions. The weekly sales per operating store was $616,000, 4.4% higher than Q3 2011. Home Depot’s CEO, Frank Blake, commented that the Q3 result beat its own expectations. It is not a one-time gain, but an overall improvement of the housing market, and at the very beginning. Furthermore, Hurricane Sandy has created huge demand about the company’s products and services. The CEO said that Home Depot has shipped around 4,000 truckloads to assist communities. Hurricane Sandy would bring more sales to the retailer, but its timing is not certain. Home Depot thought that it would recognize more sales in several quarters, which might have a similar sales impact compared to Hurricane Irene’s.
Home Depot has a strong balance sheet with balanced debt and equity. As of October, its stockholders’ equity was $17.74 billion; the long-term debt was $10.78 billion and cash on hand were $2.5 billion. Currently, Home Depot is trading at $63.38 per share; the total market capitalization is $95.54 billion. Home Depot is trading at 17.1x forward earnings and 1.2x PEG. It is paying 29 cents quarterly dividend with a 1.9% dividend yield.
Home Depot’s closest competitor, Lowe’s (NYSE: LOW), has experienced the same increases, but a more volatile trend. Year-to-date, the returns of both Home Depot and Lowe’s are quite similar, but they have diverged since May. 
Indeed, Home Depot is worth it. Over the previous 12 months, Home Depot has better operating figures with inexplicably similar valuations compared to Lowe’s. 

Net margin (%)
ROIC (%)
Forward P/E
Dividend yield (%)
As we can see, Home Depot had a higher net margin than Lowe’s. Its return on invested capital was nearly two times higher than that of Lowe’s. Both employed the same capital structure, paid the same dividend yield and received similar valuations. 
My Foolish Take
With a leading position in the world and  better operating figures than its peer, but similar valuations, Home Depot is definitely a better pick among the two. Investors might consider Home Depot, as it seems to be a nice play on the improving housing market in the US. 

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