I am neutral on Home Depot (HD) because while its business model has proven to generate strong profitability and long-term growth, its valuation multiples indicate that it trades at a premium.
Home Depot is the largest home improvement retail chain in the United States. The company operates many big-box stores across all U.S. states, 10 provinces of Canada, and 32 Mexican states. (See Analysts’ Top Stocks on TipRanks)
Home Depot operates in over 2,000 locations and is the employer of over 500,000 people.
The company receives millions of orders every year from customers who use its products. The company also owns Interline Brands (The Home Depot Pros), which has 70 distribution centers across the U.S.
Home Depot’s second-quarter 2021 report showed revenues of $41.1 billion, beating consensus estimates of $40.8 billion, with an increase of 8.1% as compared to $38.1 billion in the second quarter of 2020.
The company also showed earnings of $4.53 per share versus an expected earnings per share of $4.44. In addition, total same-store sales showed an increase of 4.5%, which was less than the 5% growth expected from analysts.
Home Depot reported that the Kitchen and Bath, and Lumber segments were its strongest departments. However, the Paint, Hardware, and indoor and Outdoor Garden segments showed reduced sales when compared to Q2 2020.
The company also noted a 5.8% decrease in customer transactions compared with a year earlier; however, it reported average tickets were larger by 11.3%. Moreover, sales per retail square foot grew to $663.05, up 5.3% from a year earlier.
Ted Decker, president and COO of Home Depot, reported that inflation contributed to a boost in sales, stating that lumber prices peaked during Q2 2021, but have since seen a decline. Inflation from categories of core commodities also positively impacted the average ticket growth by approximately 420 basis points.
Home Depot’s brick-and-mortar stores remained open during the pandemic when many Americans invested in home remodeling and renovation projects.
The company’s revenue growth is expected to slow down in 2021. However, the company also stated that its same-store sales in the first weeks of August were aligned with trends in Q2 2021, and they predict a supportive environment for spending on home improvement in the coming years.
Home Depot’s stock looks richly valued right now as its EV/EBITDA ratio and price-to-normalized earnings ratio both indicate the stock is trading above its historical average.
The EV/EBITDA ratio is currently 16.4x compared to its five-year average of 14x and the P/E ratio is currently 23.4x compared to its five-year average of 21.1x.
Wall Street’s Take
From Wall Street analysts, Home Depot earns a Strong Buy analyst consensus based on eight Buy ratings, one Hold rating, and zero Sell ratings in the past three months. Additionally, the average Home Depot price target of $359.25 puts the upside potential at 6.2%.
Summary and Conclusions
Home Deport is one of the most successful retailers in the world, as it has successfully carved out a niche for itself in the specialty retail industry.
It has not only survived, but thrived, in the e-commerce era and continues to grow its profitability and efficiency metrics. The company also benefits from strong customer loyalty and is poised to continue generating solid growth for years to come. On top of that, Wall Street analysts are overwhelmingly bullish on the stock.
That said, the stock’s valuation appears to be pretty rich right now, so it might be prudent for investors to wait for a pullback before adding more shares.
Disclosure: At the time of publication, Samuel Smith did not have a position in any of the securities mentioned in this article.
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