Blue-chip dividend payer Home Depot has handle on housing crisis
Sep 16th 2009 10:20AM
Updated Dec 4th 2009 3:28PM
In 2003 -- or about the time it began to dawn on some then-dismissed Cassandras that folks were using their houses as automatic teller machines -- Home Depot booked $65 billion in sales (that's for its fiscal year ended February 2004). Three years later -- at the height of the bubble -- the nation's largest home improvement retailer's sales topped $79 billion. Net income during the bubble likewise grew handsomely, to $5.3 billion from $4.3 billion.
Naturally, the market rewarded such performance: If you picked up this component of the Dow Jones Industrial Average in early 2003, you were sitting on a paper gain of 70 percent by the end of 2006.
And then (pardon the expression) the roof caved in.
A stock that routinely fetched more than $40 a share during the housing craze now sits around $27 -- and that's after a torrid 50-plus percent run off the market's early March low, when it was going for around $18.
Make no mistake, the housing crisis is far from over and Home Depot's stock has made quite a big move in a very short amount of time. But looking out over the next 12 months and beyond? This dividend-paying blue chip sure looks like a buy.
Partly that's because Home Depot is doing an admirable job in transforming itself from a high-growth company to a more mature business that focuses on things like costs, margins, return on invested capital and cash flow -- and partly because there are so many millions of foreclosed homes and other houses in need of maintenance, analysts say.
"The key is that this is a company that has transitioned to maturity," says Jaison Blair, senior equity research analyst at Rochdale Securities, who rates the shares a Buy. "It reminds us of AutoZone (AZO), which used to be an awesome growth story but then saw returns on its store base eroding."
What that means: Home Depot spent 2008 slashing costs, closing underperforming stores and getting much more conservative with its capital. Now it's in the process of making its supply chain more efficient. The upshot is a leaner company where a larger portion of revenue should find its way to the bottom line. Furthermore, the company's cash flow and balance sheet should allow it to buy back stock, Blair says. (When a company takes its own stock out of circulation, remaining shares become worth more.)
Then there's the matter of the company's superior value proposition versus major competitor Lowe's (LOW), says Brian Sozzi, an analyst with Wall Street Strategies, who rates shares at Buy. "Consumers are not going for large remodels or big-ticket items," Sozzi says. "They're looking for things to update quickly and cheaply, like wallpaper, paint and carpeting. Home Depot is very successfully picking this low-hanging fruit and, in my opinion, taking market share from Lowe's."
Let's also not forget the millions of foreclosed homes sitting on the market for nine months or more, says Sozzi. Eventually they will need a big-time sprucing up before they can be put back on the market.
Finally, there's the matter of valuation. Home Depot shares still look compellingly priced, even after the recent run up. The stock currently trades at less than 17 times forward earnings, offering about a 14 percent discount to the S&P 500, according to Thomson Reuters. Analysts' average price target stands at $29.50, making the implied upside 8 percent in the next 12 months or so. Throw in the current dividend yield of 3.3 percent and you get a theoretical upside of more than 11 percent.
Are those returns achievable? Well, no one has a crystal ball, but if it's any consolation, analysts have been way too conservative in their forecasts for quite some time: Home Depot has beaten Wall Street's estimates by at least four cents a share for six quarters in a row.