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Home Depot: Facing Hard Comparables for 2022
Stock Analysis & Ideas

Home Depot: Facing Hard Comparables for 2022

Home Depot (HD) operates as a home improvement retailer. We remain neutral on the stock despite it being a high-quality company.

Home Depot Tumbles

We recently wrote an article about Home Depot when the stock price was over $400. In that article, we placed a neutral rating on the stock because there was very little upside relative to analysts’ average price target.

Since then, the stock has fallen from those levels, hitting a low of almost $300 before rallying to approximately $320 as of this writing. Investors were likely disappointed by management’s 2022 outlook.

Home Depot expects sales growth to be “slightly positive” and operating margins to remain flat relative to 2021. In addition, it expects earnings growth to be in the low single digits.

This is much lower than its historical growth rates, especially compared to the growth it saw during the pandemic. That being said, it’s understandable that growth will be lower in 2022 because of the difficult comparisons to 2021.

As a result, it’s possible that growth could accelerate in the years following 2022 unless we experience a recession.

Competitive Advantage

There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the earnings power value (EPV).

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value can be measured using total asset value. If earnings power value is higher than reproduction value, then a company is considered to have a competitive advantage.

The calculation is as follows:

EPV = EPV adjusted earnings / WACC

$257.7 billion = $20.1 billion / 0.078

Since Home Depot has a total asset value of $71.9 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Home Depot, it would require $71.9 billion of assets to generate $257.7 billion in value over time.

The second method is by looking at a company’s gross margins because it represents the premium that consumers are willing to pay over the cost of a product or service.

An expanding gross margin indicates that a sustainable competitive advantage is present. If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.

In Home Depot’s case, gross margins have remained flat (around the 33-34% range) in the past several years. As a result, its gross margins indicate that a competitive advantage is present in this regard as well.

Wall Street’s Take

Turning to Wall Street, Home Depot has a Strong Buy consensus rating, based on 18 Buys, four Holds, and zero Sells assigned in the past three months. The average Home Depot price target of $393.05 implies 22.8% upside potential.

Analyst price targets range from a low of $320 per share to a high of $470 per share.

Final Thoughts

Home Depot saw great growth in 2020 and 2021 thanks to the pandemic, sending the stock on a huge rally. Unfortunately, this has now led to very tough comparisons for Fiscal Year 2022, resulting in a substantial price drop year-to-date.

Although the stock looks significantly more attractive at these levels, we remain neutral on the stock.

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