EUR 850.00 For Business Accounts Only

Morningstar | Home Depot Merchandising Drives Another Banner Quarter; Shares Fairly Valued

Despite increasing headwinds across the home improvement landscape, including rising interest rates (with mortgage rates up 80 basis points over the last 12 months) and declining existing home sales recently, wide-moat Home Depot continues to deliver healthy top-line results. In the third quarter, comp sales of 4.8%, which were modestly better than our 4.5% forecast, and revenue growth of 5.1%, which was a bit weaker than the 5.9% we expected, benefited from good demand across both the pro and do-it-yourself customer and the growth of the digital business (28%). EPS was handily ahead of our $2.26 estimate, at $2.51, but $0.20 of this upside stemmed from a lower tax rate in the period, which we don’t expect to repeat. With an updated outlook calling for $8 billion in repurchases in 2018 from $6 billion prior, we don't expect any major changes to our final-quarter outlook to reach the new $9.75 EPS guidance outside of higher buybacks, which will add a few pennies to our forecast. We don’t expect any material change to our $168 fair value estimate and view shares as fairly valued.

We see a few factors that could help support Home Depot’s growth even with a housing slowdown. First, the maintenance and repair business provides a sticky, consistent customer that could drive incremental purchases. Second, as the baby boomers continue to age, the do-it-for-me consumer becomes more important, and Home Depot can link pros and consumers together to facilitate home renovations, particularly as the housing stock ages and consumers stay in their homes longer. Additionally, while caution has sounded on home sales and mortgage applications, existing home sales prices are still rising, indicating that the wealth effect remains intact, spurring willingness to spend in the category. These factors support our long-term outlook, including an average 3.4% comp sales growth, 3.6% sales growth, and modest operating margin expansion of about 20 basis points per year, to 16% in 2027.

Third-quarter sales rose 5.1% to $26.3 billion, despite lapping $282 million in hurricane-related sales in the year-ago period, bolstered by same-store ticket that rose 3.5%, transaction count that increased 1.2%, and big-ticket sales (more than $1,000, representing 20% of total sales) increasing 9%. Broad-based geographical strength has persisted, with all but one region positing positive comps, as the Gulf region was lapping last year’s boost from Hurricane Harvey. The gross margin expanded 23 basis points, to 34.8%, with the primary benefit stemming from a change in accounting standards, with both higher supply chain and transportation costs weighing on the metric to the tune of 23 basis points. Guidance calling for a full-year operating margin expansion of 37 basis points (from 34% in 2017), modestly lower than the 41 basis points previously anticipated, could be weighed down by the reversion of third-quarter gains in commodity cost inflation. However, operating expenses, which were expected to rise at a 137% pace of sales rate at the end of last quarter, are now set to rise just a 131% clip of sales, offsetting a lower gross margin gain. In the third quarter, operating expenses deleveraged 23 basis points, to 20.1% of sales, as 90 basis points of leverage in the core business were more than offset by the adoption of the new accounting standard and strategic investments (which together cost 113 basis points).

On a capital allocation front, the company has again upped its share repurchase outlook and now plans to buy back $8 billion in shares this year, double Home Depot’s initial fiscal 2018 outlook of $4 billion. The firm plans to facilitate the remainder of the purchases with both cash and new debt, as it seeks to refinance some debt and add incremental debt to its balance sheet to manage to its 2 times debt/EBITDA leverage target. Our concern historically has been that as the company manages to this leverage target, debt could become more difficult to raise (from both a cost perspective as interest rates rise, and from slower EBITDA growth, limiting capacity), which in turn could affect the level of share repurchases in any given year that are to be undertaken. This could lead to lower EPS growth ahead with a slower rate of share repurchases, leading to multiple contraction. As noted above, our existing five-year average EPS growth calls for Home Depot to achieve a low-double-digit pace.