Buy Home Depot, Lowe's, Wal-Mart Despite Floundering Economy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After the release of poor job results for May 2012, which were 20% lower than forecasts, investors are erring on the cautious side in retail. Surprisingly, however, Home Depot (NYSE: HD), Lowe's (NYSE: LOW), Wal-Mart (NYSE: WMT) all appreciated in value for the day. The stocks are cheaper than the broader market on a multiples basis and still possess impressive fundamentals. Over the last year alone, Lowe's, Home Depot, and Wal-Mart appreciated by 16.9%, 42%, and 33.4%, respectively while the S&P 500 was roughly flat. I expect this momentum to generate outperformance over the next two years or so when mainstream media chatter stops legitimizing "double dip" fears. In the meanwhile, these iconic firms are relatively safe under low betas.
Home Depot is still fairly expensive at 19.7x past earnings and future growth does not offer a meaningful margin of safety. 2012 EPS is expected to hit $3.31 in 2013 and then grow 13.7% annually over the near-term - nominally less than what it has generated over the last 5 years. Based on these expectations and a 16x multiple, the future value of the stock in 2016 is $88.50. Discounting backwards by the standard rate of 10% yields a price target of $54.94 - more or less in-line with consensus and the current valuation.
With that said, Home Depot is still safe given its beta of 0.8 and reasonable 2.2% dividend yield. It should further be noted that recent performance has been above expectations. Lowe's is an ideal supplementary investment that comes at a lower price for greater expected growth. The company is expected to generate 15.7% annual growth over the next 5 years, which means 2016 EPS of around $4.58. A 15x multiple would place the future stock value at $68.70. That means a 10% discount rate still offers a more than 50% margin of safety. It appears that the market is factoring in an absurd discount rate of 20%. Investors are thus encouraged to go long on Lowe's in addition to a Home Depot investment.
Moving away from home improvement to more general retailing, Wal-Mart still offers incredible value at an affordable price - "always." The company is 70% less volatile than the broader market and it, ironically, is an attractive hedge against macro uncertainty. Moreover, the company gets the best of both worlds: if the economy turns sour, consumers will substitute to lower-end retailers; if the economy improves, consumers will have more money to spend and thus purchase more. At a 15x multiple and expectation for 8.7% annual growth over the next 5 years, Wal-Mart has not had the future fully accounted in its stock price. The Street may only rate the stock a "hold," but consistent performance makes Wal-Mart a mainstay holding for the risk-averse. Emerging market opportunities and improvements in technology to reduce labor costs further reinforce my optimistic call.
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