Home Depot Inc. (NYSE: HD) remains BUY.
This is still an astoundingly high ROIC. Most of the decline is because the company maintained temporarily high levels of liquidity ($14.65 billion of cash on the balance sheet) and because it suspended share repurchases. One reason the company has such a high ROIC is because it avoided acquisitions and made existing assets more productive. Home Depot’s ROIC has been a key part of our thesis for a long time. The success of CEO Menear’s proposed acquisition of HD Supply will be an important indicator of his ability to select good ‘projects’ and deploy capital effectively.
HD is also seeing growth in household formation.
HD’s customer satisfaction is improving and the company has seen that consumers are consolidating the group of retailers that they shop with and increasingly blending in-store and online shopping. HD’s appear to be excited to celebrate the upcoming holiday season.
The company is essentially replacing some of the current year’s temporary bonuses with permanent compensation increases. We think it is an important and necessary decision as we don’t want to see the company lose seasoned workers and have customer service suffer.
Sales to professionals and do-it-yourself customers were both up in the double digits. Sales to DIY customers were stronger, but the Pro business is improving and delivered its best performance of the year in 3Q.
The company’s FY21 business outlook remains suspended because of uncertainty related to COVID-19 and its impact on the economy. While results continue to be very strong management does not think that it is prudent to project current trends into the future. We agree.
Third-quarter sales increased 23.2% to $33.5 billion.
Comparable sales increased 24.1%, which was above the consensus growth estimate of 16.9%, according to StreetAccount. All 14 of the company’s merchandising departments posted double-digit comps in the quarter and all 19 regions posted double-digit comps. Lumber, home dâ šcor and storage products had among the highest sales.
Comp sales at U.S. stores rose 24.6% in 3Q20. Online sales were up about 80% in 3Q. The company said that online conversion is up, downloads of the mobile application is up substantially, as are the number of people using the so-called app. U.S. comps were up 22.6% in August, 28.5% in September and 23% in October.
Comparable customer transactions increased 13%. The average comp ticket was up 10% driven by customers taking on new projects 1and by shoppers ‘trading up’ for innovative items. There was also some benefit from inflation in lumber prices as well as double-digit unit comps for lumber despite the higher prices. The average price of lumber was up 130% during the quarter but dome prices had eased by the end of 3Q. Transactions above $1,000, which represent about one-fifth of U.S. sales, rose about 23%. Sales of appliances, vinyl plank flooring and lumber were all strong. The company said that 4Q comparable sales were off to a strong start, accelerating from 3Q levels on the early launch of some Black Friday and holiday deals. Both HD and Lowe’s do a great job with gift sets.
Operating income was $4.85 billion, or 14.47% of sales, which was flat on a year-over-year basis. Our estimates were $4.1 billion and 13.8% of sales.
Profitability benefitted from the elimination of some promotional events.
Sales were stronger than expected but the company invested in its employees during the pandemic and made record bonus payments linked to the strong performance.
In 3Q21, the trailing four-quarter return on invested capital declined to 41.6%, down 350 basis points from the prior year’s third quarter. This is still an astoundingly high ROIC. Most of the decline is because the company maintained temporarily high levels of liquidity and because it suspended share repurchases.
On November 16, Home Depot announced an agreement to acquire HD Supply Holdings, a wholesale distributor of electrical, janitorial and plumbing supplies. Home Depot is actually reacquiring its former business unit. Home Depot sold the division to a group of private-equity firms in 2007. The private equity firms took HD Supply public in 2013. Home Depot is paying $56 for each share of HD Supply (Nasdaq: HDS). The total enterprise value (market capitalization plus debt minus cash) is $8 billion.
Home Depot is buying the business to expand its sales to professionals. Mr. Menear is confident that Home Depot’s success in serving this group of customers will help the combined company to gain more share in the $55 billion MRO market.
EARNINGS & GROWTH ANALYSIS
Our estimate of full-year operating margin is now 14%, which is up from 13.75% previously, but down from 14.2% before the pandemic.
We are not projecting a continuation of the pandemic level of growth. In fact we are still modeling a small decline in full-year sales because we think the FY21 levels will be hard to replicate. The consensus is for sales to be roughly flat. Our estimate does not yet include the addition of HD Supply, which the company expects to boost earnings in FY22. It is possible-to-likely that the addition of HD Supply’s $6 billion of annual sales will push sales above FY21 levels for the full year.
We are modeling about 4% sales growth, which assumes comp growth of about 4.0%, along with about five new stores a year.
HD could get some help from leverage on depreciation and amortization because it has not made any major acquisitions or increases to the store base.
A partial offset to earnings is that interest expense is likely to rise.
FINANCIAL STRENGTH & DIVIDEND
Before HD suspended its repurchase plan in March of 2020 because of the COVID-19 epidemic, management planned to repurchase at least $5 billion of shares in FY21 under a $15 billion plan authorized in February of 2019. The remaining capacity is about $7.7 billion. HD has repurchased over $80 billion of its stock since 2002.
In March of calendar 2020, HD expanded the capacity of its commercial paper program to $6 billion from $3 billon. HD also entered into an additional 365-day $3.5 billion credit facility, which raised revolver capacity to $6.5 billion, which is more than enough to back up the commercial paper program.
There is no change in our assessment of financial strength because we always went through the footnotes and included operating leases in our assessment of fixed charges. This shifts our focus to debt coverage from measures like debt-to-equity and debt-to-capital. HD could be at risk if EBITDA declined considerably.
FY18 dividends totaled $3.56 per share. In the 4Q18 release, management raised the dividend by almost 16% to $1.03 per quarter. FY19 dividends totaled $4.12 per share.
MANAGEMENT & RISKS
Carol Tome, the company’s outstanding CFO, retired in August of 2019 after 18 years as the finance chief. She retired as one of the longest-tenured CFOs in the S&P 500. She was lured out of retirement and will become the CEO of UPS, the big package delivery company that is known for its brown trucks rather than its orange aprons. Richard McPhail became CFO in September 2019.
Based on our recent experience, HD is doing a better job executing its business plan. Lowe’s hired Marvin Ellison as CEO. Mr. Ellison was head of U.S. Stores at HD before he left to become CEO of J.C. Penney. We believe he has the expertise to improve margins at Lowe’s.
We think HD has significantly improved service levels.
However, at 2.2%, HD‘s dividend yield is substantially higher than the 0.85% yield on the 10-year Treasury note and, in our opinion, worth considering.
On November 18 at midday, BUY-rated HD traded at $273.63, up $1.16.