It’s time to discuss one of my most profitable holdings: Home Depot (HD). The Atlanta, GA-based home improvement retailer continues to be a money-making machine as the stock is up more than 30% year-to-date despite a global recession. This time is different as housing strength (yes, in a recession) is boosting sales, while shelter in place orders caused customers to invest more in their own homes. The just-released second-quarter earnings were a blowout success as everything went through the roof. Total sales, same-store sales, margins, earnings, cash flow, etc. In this article, I will discuss these earnings and tell you why this is the best case of ‘hold, don’t trade’.
This Time Is Different
The most beautiful thing about the stock market is that every situation is different. In the prior recession, housing was the core problem as a series of defaults in that space and rapidly plunging home prices caused a global domino effect. As a result, the Home Depot stock price fell by roughly 60% between the start of 2007 and the 2009 lows. While I am typing this, the stock is up 30% year-to-date and up 90% from the Q1/2020 lows.
That said, after some weakness in the first quarter, the company reported one of its strongest quarters of the past few years as non-GAAP EPS soared to $4.02. Not only is this 27% higher compared to the prior-year quarter, but it is also way above estimates as consensus expectations were $3.68.
This being said, let’s take a look at the top of the income statement as this impressive EPS result was provided by very strong sales. In the second quarter, net sales hit $38.1 billion. This is up from $30.8 billion in the prior-year quarter, which translates to a 23.4% increase. The company added two new stores, bringing the total to 2,293. Same-store sales were up 23.4% as well. Meanwhile, analysts were looking for ‘just’ 10.9% year-on-year growth. Same-store sales in the United States were up 25%.
Furthermore, in the second quarter, the company saw 511.5 million customer transactions. This is up 12.3% year on year. The average ticket was up 10.1% to $74.12. Sales per retail square foot improved by 23.5% to $629.38.
To cope with rapidly growing demand, Home Depot invested roughly $480 million in additional benefits for its associates, including weekly bonuses for hourly associates in stores and distribution centers. Since the start of the year, the company has spent roughly $1.3 billion on enhanced pay and benefits in response to COVID-19. Just to give you an interesting fact, the year-to-date bonuses have the same value as the entire Home Depot market cap at the end of the 1980s.
Anyhow, the company generated roughly $11.6 billion in cash as cash from operations soared from $8.5 billion to $14.8 billion. A large part was caused by $6.8 billion in working capital. Capital expenditures dropped from $1.2 billion to $1.0 billion, resulting in free cash flow worth $13.8 billion. Cash used for financing purposes was $1.8 billion. This is down from $6.5 billion in the prior-year quarter as the company saw proceeds from long-term debt worth $4.9 billion. Repurchases of common stock were $790 million, down from $2.6 billion in the prior-year quarter. Cash dividends were $3.22 billion, an increase of 7.7% compared to Q2 of 2020.
Adding to that, the company declared a $1.50 dividend – in line with previous. This will be paid on September 17 and implies a forward yield of 2.08%. The stock goes ex-dividend on September 2.
With regard to margins, the company boosted its gross margin by 20 basis points to 34%. The operating margin was flat at 15.9%. Merchandise inventories fell by 8.4% to $13.5 billion.
So Good, It’s Bad
Almost at the same time as the earnings release, investors got the news that building permits were up significantly. Pictured below are 1-unit building permits, which advanced more than 15% in July after NAHB housing sentiment hit a new all-time high. In other words, while Home Depot did beat earnings, the sentiment was (and still is) very positive.
To me, it makes sense that Home Depot is currently trading down more than 1% after earnings, while the stock was up roughly 3% pre-market. As already mentioned in this article, the stock is up 30% year to date, trading at 2.8x sales. A lot has been priced in. I strongly believed that traders used the good news to sell some of the shares they bought when housing sentiment was low.
Note that I said ‘traders’ were selling. I have not spoken to a single long-term investor looking to sell shares. While the company is somewhat overbought at current levels, I will stick to my shares. Management has done a tremendous job growing its business in a tough business environment, and even though the risk/reward is bad with a share price close to $300, I have little doubt the long-term trend will remain up.
The second quarter was a blowout quarter. Sales were much higher than expected and benefited from an increase in transactions, average ticket size, and a boost in general housing sentiment.
However, given the high expectations and blowout numbers, I expect the stock to go sideways for some time as we seem to have reached ‘peak risk/reward’.
If the economy is able to accelerate after the election and beyond (based on less election-caused uncertainty), I have little doubt that Home Depot will continue to boost its dividend and even accelerate its buybacks. Hence, my message is: keep buying for the long term. At least, that’s what I will be doing.
Thank you very much for reading my article. Feel free to click on the “Like” button and don’t forget to share your opinion in the comment section down below! My long-term investments are stated in my Seeking Alpha biography.
Disclosure: I am/we are long HD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.