EUR 850.00 For Business Accounts Only

Morningstar | Solid 2019 Sales Outlook Offset by Margin Pressure at Home Depot; Shares Fairly Valued

With the housing market well into its current cycle, year-over-year improvement has become incrementally more difficult for many businesses. Slower growth of home prices, measured housing starts growth, and dampened cadence of turnover, particularly at the low-priced end of the market are headwinds that Home Depot must contend with. We are not concerned, however, about an imminent slowdown in the business, as mitigating factors like age of housing and rising headship rate provide defense from a near-term meaningful degradation in demand. We think that as a market leader, the company is best positioned to continue to still win modest share thanks to solid merchandising and seamless omnichannel experience (with e-commerce representing 8% of sales in 2018, with 50% of orders executed online with pickup in store). Additionally, opportunities to grow the pro business, supported by ongoing investments, should help bolster the firm’s top line, allowing for the natural leverage of expenses.

The outlook for 2019 overall is within our long-term perspective for wide-moat Home Depot, which incorporates average comps of 3% and modest operating margin improvement over the next decade at about 10 basis points annually, given the maturity of the business and the position in the economic cycle. While the firm’s 2019 projection was higher on the comp side than our forecast (at 5% versus 4%, respectively), this upside should be offset by higher expenses as the company spends to improve its brand intangible asset, leading to an operating margin of 14.4% versus our 14.7% estimate. In this vein, we don’t plan any material change to our $170 fair value and view shares as fairly valued, trading at 18 times Home Depot’s $10.03 EPS guidance (which is below our $10.28 and consensus $10.25 outlooks).

Fourth-quarter earnings per share of $2.09 were a bit lighter than we anticipated, as 3.2% comps fell short of our 4.7% forecast, hindered by wet weather, and a $0.16 one-time charge surrounding trade names within Interline brands. Total sales rose 10.9%, helped by the addition of $1.7 billion in revenues from the company’s 13th week in the period, and high-ticket sales (over $1,000) which rose 4.8%. Both average ticket and transactions posted positive gains, at 2.3% and 0.9%, respectively, despite the difficult weather. Gross margin increased 19 basis points, to 34.1% helped by the new accounting standard (53 basis points), but hindered by higher supply chain and shrink costs, along with a negative mix shift across products sold. Operating expenses also expanded by nearly 80 basis points, as the impairment loss and accounting standard change more than offset well-implemented cost control gains.

All in this resulted in operating margin performance of 14.4% in 2018, relatively flat to 14.5% in 2017, even with incremental spend on improving the business. Strength in cash flow allowed the Board to raise the dividend by 32%, to $1.36 per quarter, bringing the forward yield to around 3%. Furthermore, with just $5 billion in share repurchases planned, we think there could be upside in the company’s earnings per share target of $10.03. In recent periods, the company has surpassed its initial buyback expectation, averaging $7.5 billion in repurchases over the last five years. As EBITDA rises, we expect any incremental cash will be repurposed toward repurchases (outside of capital already allocated for reinvestment into the company), as we expect Home Depot will manage to its 2.0 times debt to EBITDAR target as closely as possible.