What Home Depot Revealed about the Housing Market
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of the things that I often find with private investors is a sense of bewilderment at just what is going on with analyst estimates and target prices. This is rarely more prevalent than in businesses whose prospects are ultimately determined by a big macro theme like housing.
Let’s take Home Depot (NYSE: HD) as an example. I think the US housing market is going to improve and gradually this will get baked into analyst estimates and targets. In summary, investors should not miss the opportunity to try and get ahead of upgrades.
The reason I think this is that analysts don’t make big macro calls. Instead they tend to prefer a linear join-the-dots approach based on a mix of historical precedents and derivations from industry statistics. I’m not knocking this approach -- I use it myself -- but if you do have a macro call to make, you can get ahead of the upgrades. In terms of housing, there is an article linked here that takes you through some of the recent positive data on housing. If you don’t share this view than read no further!
Home Depot Earnings
Full-year guidance was raised to GAAP EPS of $1.95 from $1.90. Superficially the numbers weren’t great but the pull-forward effect of unseasonably warm weather in the winter was always likely to skew the results somewhat. In order to demonstrate this here are the revenue and gross margin numbers by quarter.
The year on year growth comes in at a paltry 1.7%. No matter, by smoothing out the effect of the pull-forward in Q1 we can see that the underlying picture is a lot stronger. Let's look at numbers by the half-year.
Note in the following chart that H1 2012 is growing at a 3.6% clip, which is pretty good. In addition in the first half of last year Home Depot had strong sales from roofing repairs thanks to hurricane Irene.
Furthermore, the commentary around the results was a lot more confident than it has been for a while. Home Depot, rather like its chief rival Lowe’s (NYSE: LOW), has been reticent to call a recovery in the housing market amidst pointing out that its prospects were based on GDP type growth and whatever operational efficiencies they could squeeze out of their respective companies. This is a sound approach and it encourages analysts not to pencil in overly optimistic assumptions.
A More Positive Outlook on Housing
I detected a change of tone in the conference call for two main reasons.
Firstly, the company was keen to emphasize that whereas previously it had seen its growth as correlating with overall GDP growth -- which most forecasters have as slowing -- now it is seeing housing as a "bit of a bright spot." Indeed housing is back to being a positive contributor to GDP growth. Moreover, management stated that it saw signs of "stabilization" in the key Florida and California housing markets and gradual improvement overall in housing.
The second reason is that the more discretionary items seem to be doing better. For example décor, kitchens, baths, flooring and plumbing were called out as outperforming while garden and building materials were down. Moreover the last two categories were down under plausibly mitigating circumstances. The drought has held back gardening sales and building materials were up against tough comparisons following the hurricane last year.
Given the strength in the tools category it was somewhat surprising to see Stanley Black & Decker (NYSE: SWK) negative on the day although the market may not like the European exposure. Similarly, a read across from the outperforming segments should mean that Bed Bath & Beyond (NASDAQ: BBBY) investors have cause for optimism. Both these stocks declined on the day and both have lowered guidance recently. With Stanley it was largely due to currency effects but Bed Bath & Beyond disappointed with generally weak guidance. Both these names are worth a look because their evaluations look cheap down here.
Essentially, the core of Home Depot performed well and I think this is confirmed when we look at what Lowe’s reported in its last set of earnings.
I think there is more to come from the home improvement stores.
Where Next for Home Depot?
The company is a cash-generating juggernaut and the stock remains cheap. Trailing free cash flow generation of $5.1 billion is a testimony to the underlying strength of Home Depot and if you buy the story of a housing market recovery it would not be unreasonable to see this stock better priced with a $60 handle.
I think the stock remains attractive. As we have seen from 2006 onwards, housing markets take a long while to finish changing direction and at the moment we seem to be in the early stages of a slow but gradual recovery phase. There is still time to get in before analysts start upgrading.
SaintGermain has a position in Home Depot. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Bed Bath & Beyond and The Home Depot. 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. If you have questions about this post or the Fool’s blog network, click here for information.