Image Shown: Shares of Home Depot Inc have moved significantly higher year-to-date and are up approximately 21% through the end of normal trading hours on August 17.

By Callum Turcan

On August 17, Home Depot Inc (HD) reported second quarter earnings for fiscal 2021 (period ended August 1, 2021) that beat both consensus top- and bottom-line estimates. Comparable sales were up 4.5% year-over-year last fiscal quarter though shares of HD slid lower during the trading session that day as investors were expecting even stronger performance. Shares of HD are up roughly 21% year-to-date as of the end of the normal trading session on August 17 (that includes the impact of the ~4% drop in shares of HD after its earnings report), and in our view, investors were locking in some profits. We liked what we saw in Home Depot’s latest earnings report and includes shares of HD as an idea in the Dividend Growth Newsletter portfolio.

Earnings Update

In the fiscal second quarter, Home Depot’s GAAP revenues rose by 8% year-over-year to $41.1 billion, marking the first time in the firm’s history it reported a quarterly sales figure north of $40.0 billion. Home Depot’s comparable store sales in the US grew by 3.4%, and management noted during the firm’s latest earnings call that its division in “Mexico posted double-digit positive comps” though its comparable store sales performance in Canada “(was) essentially flat in local currency” versus fiscal year-ago levels. The company cited headwinds and restrictions on activities due to the coronavirus (‘COVID-19’) for holding back its Canadian results. Home Depot’s GAAP operating income increased 9% year-over-year last fiscal quarter, aided by sales growth and economies of scale.

On the e-commerce front, management noted that “sales leveraging (of its) digital platforms (was) essentially flat during the [fiscal] second quarter, as (it) lapped digital sales growth of approximately 100% in the second quarter of last [fiscal] year,” which we view as both understandable and a positive. The company’s omni-channel selling capabilities are impressive and holding up well, even as lockdown and quarantine measures have largely ended in the US over the past several quarters (the “delta” variant remains a known unknown, as the late Donald Rumsfeld would say, and we are monitoring the situation).

Home Depot exited the fiscal second quarter with a $31.6 billion net debt position (inclusive of short-term debt) along with sizable operating lease liabilities on the books as well. During the first half of fiscal 2021, Home Depot generated $8.9 billion in free cash flow and spent $3.5 billion covering its dividend obligations, though it also spent $6.9 billion buying back its stock. We view Home Depot’s net debt load as manageable given its sizable “excess” free cash flows (free cash flows less dividend obligations), though we would prefer that management pare down the firm’s net debt load going forward.

Changing Consumer Trends

Home Depot did report some significant shifts in customer activity last fiscal quarter. For instance, management noted during the firm’s latest earnings call that its weekend sales performance had “strengthened” relative to its weekday performance. This was attributed to customers resuming pre-pandemic routines (such as commuting and going to work on the weekdays), though Home Depot noted that its customers remained “engaged in home improvement projects.” Furthermore, management noted that the firm’s ‘Pro’ customer “outpaced the [do-it-yourself] customer for the second quarter in a row” as its “customers [are] more comfortable taking on larger projects.”

In our view, Home Depot’s major growth engine going forward is its professional customer base (such as contractors and home builders) as its casual customer base, those that were focused on DIY home improvement projects during pandemic-related lockdowns, is now pivoting towards other endeavors. However, demand remains strong from its casual DIY customer base, though this segment of Home Depot is unlikely to put up the growth rates seen during the initial phases of the COVID-19 pandemic. Last fiscal quarter, Home Depot’s average ticket size was up 11.3% and its sales per retail square foot was up 5.3% year-over-year, though its number of customer transactions was down 5.8% year-over-year.

MRO Acquisition and Potential Infrastructure Bill Upside

With that in mind, please note Home Depot recently acquired HD Supply Holdings which is billed as “a leading national distributor of maintenance, repair and operations (‘MRO’) products in the multifamily and hospitality end markets” through a deal worth ~$8 billion by enterprise value. That deal closed in December 2020 and significantly improved Home Depot’s footprint in the ~$55 billion MRO market in the US and Canada. For reference, Home Depot sold off HD Supply back in 2007, before later buying back the business.

This deal is important for a few reasons. One, it strengthened Home Depot’s presence in the fragmented MRO business and grew its exposure to the professional side of its industry. Two, the deal is expected to be accretive to its earnings per share going forward (starting in fiscal 2021) with ample room for synergies over the long haul. Three, Home Depot is now incredibly well-positioned to capitalize on a potential ~$1 trillion infrastructure bill working its way through the US Congress that recently passed the Senate.

Though it is far from certain that the bill will get signed into law, the bipartisan piece of legislation offers Home Depot a major potential catalyst that is purely incremental to its reasoning behind acquiring HD Supply in the first place (meaning Home Depot wanted to bulk up its MRO business by buying HD Supply long before the chances of a bipartisan infrastructure package immerged). The company’s MRO business would likely be a major beneficiary of the infrastructure bill alongside its professional-facing retail business.

Management did not say much specifically about the MRO business during Home Depot’s latest earnings call, though the firm did have this to say in response to an analyst’s question on the subject (emphasis added):

“…[W]e're very pleased actually with our MRO business and the acquisition of HD Supply. The business there is very solid. What we're excited about, candidly, with that business, is the opportunity to much better serve 50 million households in the multi-family space.

Not only can we serve them with MRO products, but obviously as we have relationships and build that through our MRO business, the opportunity to then participate in capital refreshes for those property owners on those 50 million households that are in the multi-family, is a huge opportunity for Home Depot going forward. So we're super pleased with the business and the progress that we're making there.” --- Craig Menear, CEO and Chairman of Home Depot

Home Depot has multiple growth catalysts at its disposal, and we are keeping an eye on the infrastructure bill making its way through Congress.

Concluding Thoughts

We liked what we saw in Home Depot’s latest earnings report which reinforced our positive view towards the name and its impressive dividend growth potential. Shares of HD yield ~2.1% as of this writing and our fair value estimate sits at $331 per share of Home Depot with room for upside as the top end of our fair value estimate range sits at $397 per share.

Downloads

Home Depot's 16-page Stock Report (pdf) >>

Home Depot's Dividend Report (pdf) >>

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Callum Turcan does not own shares in any of the securities mentioned above. Chipotle Mexican Grill Inc (CMG), Dollar General Corporation (DG), Domino’s Pizza Inc (DPZ) and The Walt Disney Company (DIS) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Dick’s Sporting Goods Inc (DKS) and Home Depot Inc (HD) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.