EUR 850.00 For Business Accounts Only

Morningstar | Home Depot’s Robust Growth Handily Outpaces Expectations; Shares Trade Rich

We don’t plan any material changes to our $165 fair value estimate for Home Depot, despite second-quarter same-store sales of 8%, which outperformed our forecast for 6% growth (on top of already robust 6% comps in the second quarter of 2017). The company adjusted its full-year outlook to account for robust spring season performance, thanks to garden and outdoor performance, which had lagged in the first quarter. The updated 2018 outlook calling for 7% sales, 5.3% comps, and $9.42 in earnings per share (from 6.7%, 5%, $9.31 prior, respectively) implies second-half sales growth at a mid-single-digit clip, comps below 5%, and more than 30% EPS growth. However, Home Depot is trading at 20 times our 2019 estimate versus a single-digit EPS increase, rendering shares overvalued.

The growth metrics Home Depot continues to capture are impressive for a relatively mature business that has planned to double its investment to remain competitive, spending $11 billion through 2020 on stores, IT, and the supply chain, offering expense leverage, and permitting modest operating margin expansion to occur (20 basis points to 16.1% during the quarter). However, this doesn’t change our long-term outlook for the industry leader, which calls for average sales growth of 3.6%, comp growth of 3.4%, and high-single-digit EPS growth (which incorporates around $6 billion in share repurchases annually) beyond 2018 as we move through the later parts of the current economic cycle. Our 2020 forecast includes gross margin of 34%, SG&A expenses (including depreciation) of 19.1%, and operating margin of 15%, ahead of the 33.6% gross margin and in line with the SG&A (18.6%-19.2%) and operating margin (14.4%-15%) guidance the company has offered, as we think product mix and brand resonance will allow it to take price on some items and further leverage occupancy costs, supporting our wide economic moat rating.

Second-quarter sales of 8.4% were bolstered by 8% comps, with average ticket rising 5% and transactions up 3% with all divisions, regions and markets comping positively. Big ticket sales (more than $1,000) rose 10.6%, helped by appliances and pro transactions. Gross margin was in line with our 34% estimate, up 36 basis points, benefiting from new accounting standards but hindered by elevated freight and fuel expenses. The SG&A (including depreciation) ratio was also about 50 basis points better than we anticipated at 17.9%, attributable to lower-than-forecast depreciation. This metric was weighed down by adoption of new accounting standards and strategic investments. Inventory rose 9%, slightly faster than sales, as Home Depot positioned properly for the addition of new businesses and increased merchandising resets. Overall, we think second-quarter results position Home Depot to deliver ongoing strength over the second half of 2018. With clean inventory, a solid supply chain, and a still healthy economic backdrop, we don’t see any imminent slowdown to the firm’s top-line demand.