Home Depot Hits a Home Run

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It’s been a profitable year for Home Depot (NYSE: HD) shareholders. Shares of the home improvement giant have risen 45% over the past twelve months, and are currently flirting with all-time highs. Home Depot has risen high on a tide of increased home sales across the country, as it pounds primary rival Lowe’s (NYSE: LOW) into the ground. Can Home Depot’s growth last into 2013, or is this bullish optimism premature?

A Robust Fourth Quarter

For its fourth quarter, Home Depot earned 68 cents per share, or $1.0 billion -- a 36% increase from the 50 cents per share, or $774 million, it reported a year earlier. Revenue rose 13.9% to $18.2 billion.

Both top and bottom line growth exceeded the Thomson Reuters’ estimate of 64 cents per share on $17.7 billion in revenue.

Blowing away Lowe's

During the quarter, Home Depot posted strong same-store sales that topped its primary rival, Lowe’s, for the 15th quarter in a row.

<table> <tbody> <tr> <td><strong>4Q Same-Store Sales</strong></td> <td><strong>U.S. Same-Store Sales</strong></td> <td><strong>Global Same-Store Sales</strong></td> </tr> <tr> <td><strong>Home Depot</strong></td> <td>7.1%</td> <td>7.0%</td> </tr> <tr> <td><strong>Lowe’s</strong></td> <td>1.9%</td> <td>1.9%</td> </tr> </tbody> </table>

Source: 4Q Earnings Reports

Both Home Depot and Lowe’s global sales include stores in Canada and Mexico. Home Depot currently controls 19% of the U.S. home improvement market, while Lowe’s trails at 16.7%, according to Euromonitor International.

Home Depot attributed its dominance of Lowe’s to several key factors:

  • Lower prices (which caused gross margin to dip from 35% to 34.9%)
  • More centralized distribution centers
  • Shifting more employees to hands-on customer service jobs
  • More locally targeted merchandise and advertising
  • Faster cost reductions than Lowe’s following the housing collapse of 2007-2009, which limited the damage to stores in Florida and California, where sales plunged up to 20%.

How does Home Depot stack up fundamentally against Lowe’s as an investment?

<table> <tbody> <tr> <td> </td> <td><strong>Forward P/E</strong></td> <td><strong>5-year PEG</strong></td> <td><strong>Price to Sales (ttm)</strong></td> <td><strong>Debt to Equity</strong></td> <td><strong>Return on Equity (ttm)</strong></td> <td><strong>Profit Margin</strong></td> <td><strong>Dividend Yield</strong></td> </tr> <tr> <td><strong>Home Depot</strong></td> <td>16.91</td> <td>1.21</td> <td>1.39</td> <td>60.96</td> <td>24.15%</td> <td>5.91%</td> <td>1.80%</td> </tr> <tr> <td><strong>Lowe’s</strong></td> <td>14.69</td> <td>1.09</td> <td>0.80</td> <td>65.51</td> <td>12.89%</td> <td>3.88%</td> <td>1.80%</td> </tr> <tr> <td><strong>Best Value</strong></td> <td>Lowe’s</td> <td>Lowe’s</td> <td>Lowe’s</td> <td>Home Depot</td> <td>Home Depot</td> <td>Home Depot</td> <td>Home Depot</td> </tr> </tbody> </table>

Source: Yahoo Finance

While Lowe’s is considered the cheaper stock, Home Depot’s premium is well deserved. With less debt, stronger return on equity and more robust margins, Home Depot is a fundamentally stronger stock.

Can Home Depot back up these fundamentals with solid top and bottom line growth?

<img src="http://media.ycharts.com/charts/5f5176cfed4b46d7380a0df8d4acce5d.png" />

HD Revenue TTM data by YCharts

From this chart, we can see that Home Depot’s aforementioned cost reductions started paying off in 2010. Although Home Depot’s revenue growth is slightly negative over the past five years, its profit growth has skyrocketed. Lowe’s, meanwhile, has both negative top and bottom line growth - which doesn’t look to change anytime soon.

Strengthening Markets

In recent quarters, Home Depot’s top line has been strengthened by brisk sales of single family homes in America. A recent U.S. Commerce Department report stated that sales of single-family homes hit a four year high in January, while the supply of homes dropped to its lowest point since March 2005.

Home Depot reported its strongest growth in New York and New Jersey, due to the damage inflicted by Hurricane Sandy last October. The company also reported positive growth in Florida, California and Arizona - three of the worst hit regions of the housing crisis. Home Depot’s sales to professional contractors also rose in tandem with consumer sales.

These improvements have also been a boon to Lumber Liquidators (NYSE: LL), which sells hardwood flooring, enhancements and accessories. While Home Depot and Lowe’s also offer flooring, Lumber Liquidators’ simpler, dedicated focus to hardwood floors has fueled its comparatively stronger price performance over the past twelve months. 

<img src="http://media.ycharts.com/charts/45a40734ca042e20709d741422cd6b07.png" />

LL data by YCharts

Same-store sales at Lumber Liquidators rose 13.2% last quarter -- outpacing both Home Depot and Lowe's. Looking forward, the company expects net sales to grow between 9% to 13%, with earnings per share forecast to rise between 13% to 28%. In my opinion, an increased taste for hardwood flooring is a strong indicator of growth in the home improvement market, as both new homeowners and existing ones opt for more expensive hardwood flooring in lieu of carpeting.

Although these signs of growth from Home Depot and its peers are encouraging, CFO Carol Tome remains cautious regarding the future, and did not offer a bullish outlook on par with Lumber Liquidators.

“While recovering, we do not believe the housing market will fully recover in 2013,” she stated. “Some may say that this is a conservative view - we would agree. But we would rather plan conservatively.”

A Conservative Outlook

After share repurchases, Home Depot expects to earn $3.37 per share for fiscal 2013 - a 12% increase from the previous year.

It also forecasts sales to rise 2%, while same-stores are expected to grow 3%. While that outlook is conservative, even its most pessimistic projections exceeded Lowe’s reported numbers in the prior quarter.

The company also boosted its quarterly dividend to 39 cents per share, while approving a $17 billion stock buyback plan.

Let’s just forget about that little side trip to China...

For now, Home Depot plans to stay in North America, after its ambitious plans for Chinese expansion backfired. Home Depot initially entered China in 2006 with 12 stores, but quickly found out that the market for DIY home improvement projects was non-existent. A Home Depot spokeswoman summed it up best, stating, “The market trend says this is more of a do-it-for-me culture.”

Apartment-based living and cheap labor that uses smaller, specialty shops crushed Home Depot’s basic business model, which was directly copy and pasted over from its American operations. By the time Home Depot decided to abandon its Chinese operations, it only had seven stores left, and was required to take a $160 million charge as a result.

However, Home Depot hasn’t given up on China completely. The company still maintains two specialty stores - one paint and flooring store and a home decorations outlet in the country. It also offered vague plans to launch online sales with one of China’s largest online retailers.

The Foolish Bottom Line

Home Depot is firing on all cylinders - its top line, bottom line, and same-store sales growth are all smoking hot. Macro factors are also heavily in its favor, and increased optimism in the housing market will cause shares to rally even further. In other words, Home Depot just might be the right stock to take home.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe's, and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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