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Home Depot: Looking to Buy on a Pullback

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·5 min read
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- By Nathan Parsh

Shares of The Home Depot, Inc. (NYSE:HD) have returned 20% so far this year, more than doubling the return of the S&P 500 index over this period of time.

The stock has benefited from incredible growth over the last year as consumers spent to upgrade their homes for various reasons during the Covid-19 pandemic. The business has been so robust that comparable same-store sales growth might be difficult to muster in the current fiscal year.


Nevertheless, investors continue to buy the stock, which now sits just pennies off of its all-time high.

We opened a position in the home improvement giant in late September and have made several additional buys since, resulting in an average purchase price of ~$277. However, is Home Depot still worth adding to at this point, or are we better off waiting for pullback? Let's review the company's most recent quarter and valuation to attempt to answer that question.

A look at recent results

Home Depot reported fourth-quarter and fiscal year 2020 earnings results on Feb. 23. Revenue increased 25.1% year-over-year to $32.3 billion, which was $1.5 billion ahead of Wall Street analysts' expectations. The company had net earnings of $2.9 billion, or $2.65 per share, compared to net earnings of $2.5 billion, or $2.28 per share, in the same period a year ago. Earnings per share came in 3 cents above estimates.

For the full year, revenue grew almost 20% to $132.1 billion. Net earnings of $12.9 billion, or $11.94 per share, was much better than net earnings of $11.2 billion, or $10.25 per share, in the previous year. Net earnings and earnings per share both increased by a mid-double-digit growth rate.

Home Depot followed up several quarters of high same-store sales growth with yet another excellent figure. Comparable sales came in at 24.5%, beating already high estimates of 19.2%. Same-store sales for the fiscal year were 19.7%. U.S. comparable sales grew 25% and 20.6% for the fourth-quarter and fiscal year, respectively.

The growth in comparable sales was fairly evenly disbtubuted between transactions and growth in average ticket size. Transactions grew 12.8% while average ticket size was up 10.8%. E-commerce, which has been a focus for Home Depot, grew 86% in fiscal year 2020, with 60% of online orders fulfilled at stores.

Gross margins of 33.6% came in a tick below estimates of 33.7% and were 30 basis points lower than the previous year. Expenses as a percentage of sales were higher by 470 basis points, which the company attributed mostly to Covid-19. The HD Supply acquisition added $100 million to expenses as well.

Home Depot ended the year with $70.6 billion of total assets, current assets of $28.5 billion and cash and equivalents of $7.9 billion on its balance sheet. This compared to total liabilities of $67.3 billion and current liabilities of $23.2 billion. Inventories ballooned 14.5% to $16.6 billion as the company ramped up production in response to the increase in demand.

Total debt was $43.4 billion, but just $1.4 billion of debt matures over the next year. Debt repayment shouldn't be an issue in my opinion, given the company's cash position. In addition, free cash flow was more than $16 billion last year. The company has generated at least $10 billion of free cash flow each of the three prior years.

Home Depot raised its dividend 10% for the March 25 payment, giving the company its 12th consecutive year of dividend growth. The company has not reduced its dividend in 34 years.

Home Depot declined to provide guidance for fiscal year 2021, citing uncertainties regarding consumer spending habits in the upcoming year. Leadership did state that comparable sales growth was expected to be flat to slightly positive if consumer spending in the second half of last year continued.

Valuation

Analysts surveyed by Yahoo Finance have an average earnings per share estimate of $12.72 for the current fiscal year. Using Friday's closing price of $319.23, Home Depot has a forward price-earnings ratio of 25.1. This is a premium to the stock's five and 10-year average price-earnings ratios of 20.5 and 19.7, respectively.

Shares of Home Depot are also higher than the intrinsic value as calculated by the GuruFocus Value chart.

Home Depot: Looking to Buy on a Pullback
Home Depot: Looking to Buy on a Pullback

Home Depot has a GF Value of $275.76. Using the most recent closing price, shares have a price-to-GF-Value ratio of 1.16. As seen in the chart above, the stock trades at its highest premium to GF Value in some time. Shares would have to decline almost 14% to reach the GF Value.

Final thoughts

Fiscal year 2020 was one of Home Depot's best years in a very long time. Comparable sales were higher by almost 20% for the year. Home Depot's ranking as the largest home improvement store in the world put the company in an advantageous position to benefit from the heightened demand for products and services.

This success has some consequences. For one, performance last year means that growth could be flat even if the increased demand for home improvement goods remains high. Investors have responded to results, driving the stock up to a valuation that the company has rarely seen before.

While we have no problem paying up for quality, and we feel that Home Depot definitely deserves to be considered high quality due to business strength and long-term results, the stock's valuation is too high at the moment. We were fortunate to acquire a fair amount of the stock at lower prices and would look to add more on a pullback. For now, we rate shares of Home Depot as a hold due to the valuation.

Author disclosure: the author maintains a long position in Home Depot.

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This article first appeared on GuruFocus.