Analysis: HD

After you receive this Alert, we will be initiating a position in The Home Depot (HD) buying 125 shares at roughly $184.08. Following the trade, HD will represent 0.85%% of the portfolio.

We are bringing HD out of the bullpen and into the portfolio. You can read our initial bullpen Alert on the company here. The company's presentation on its 2020 Long Range Financial Targets can be found here. By the end of fiscal 2020, management expects to grow sales in the range of $115 billion to $120 billion, with operating margins in a range of 14.4% to 15% and return on invested capital of more than 40%. These targets were reaffirmed by the company's fiscal 2018 results and 2019 guidance.

We believe we are initiating HD at an opportune price, as shares are down roughly $30 from its September highs and pulled back last week on its fourth quarter earnings release, which can be found here. Indeed, the 2019 earnings guidance was below street ($10.03 vs. $10.27 consensus), but Jim outlined several reasons (in our bullish thesis below) why the selloff was a buying opportunity in his RealMoney article titled, "There's No Way Home Depot Stock Should Stay Down."

"Me? I think that, periodically, you get this kind of so-called disappointment from these guys only to find out that they told the truth about the weather and they hit it out of the park in the next quarter, their Christmas quarter when you get gardening and outdoor activities plus a much stronger professional quarter, especially because this next quarter won't face difficult comparisons from a hurricane aided fall of 2017," he wrote.

Our bullish thesis on HD is mainly predicated on:

  • Weather related issues last quarter clouding the full story. "It was cold. It was snow. And perhaps, worst of all it was wet," CEO Craig Menear explained on the conference call. "Wet weather delays projects and this was evidenced in our sales performance in the quarter. In fact, as Carol will detail, ex-weather, our business performed in line with our expectations."
  • Then when management got more granular on several business departments, we learned that many parts of the business are actually doing quite well. The company saw above company average comps in tools, appliances, décor, indoor garden, building materials, outdoor garden, hardware and paint. Meanwhile, electrical, plumbing, flooring millwork, and kitchen and bath were positive although below company average. Only lighting and lumber reported negative comps, and that was primarily due to price deflation.
  • While critics of the company will point to the tough housing conditions, management expects most metrics to stabilize in 2019. At the same time, the company is seeing faster than company average comps in Pro while Do-it-Yourself customers continue to grow.
  • Cash machine business - In fiscal 2018, the company generated approximately $13.3 billion of cash from business. In fiscal 2019, management expects to generate roughly $14.1 billion in cash. From that, $2.7 billion will be invested back into the business to support strategic initiates (which help the company gain market share), $6 billion will be paid in the form of dividends (more below), and $5 billion will be spent in buybacks (more below).
  • Huge dividend boost - last week the company announced a 32% increase in its quarterly dividend. This puts the yield at about 2.94%, representing a pretty large step up from prior yields.
  • Buyback support - last week the company announced that its board authorized a new $15 billion share repurchase program that replaces its previous plan. For fiscal 2019, management expects to repurchase $5 billion worth of shares.
  • The strong dollar is acting as a headwind to comp sales, but management is expecting abating pressures cost pressures in tariffs, fuel, and transportation capacity in 2019.

We are initiating the position with a $210 price target, which reflects roughly 21x 2019 diluted earnings per share guidance of $10.03.