Stock of the Day
Sep 02, 1998
fnews.yahoo.com
Home Depot: Dip Buyers All Over It!
Nearly everyone agrees Home Depot (NYSE:HD - news) is a great company, but even some of the ardent fans were expressing concern about its stock valuation a few months ago. With the share price more than tripling to $49 in eighteen months, Home Depot had soared to a Price/Earnings Ratio of 58 in mid-July.
The mantra seemed to be "I'd wait for it to pull back a little before buying." So when the stock dropped sharply in recent weeks along with the rest of the market, many investors were quick to take advantage of the dip. On Tuesday, Home Depot slipped as low as $35.25 before roaring back on heavy volume to finish up over 3 points on the day at $41.25. It's not exactly a bargain basement price, but for a top-notch performer like Home Depot investors are apparently happy just to get a reasonable discount.
Home Depot dominates the $140 billion market for home improvement products. It has consistently delivered revenue and profit growth of 20%-30% per year. Since it came public in 1981, the stock is up something like 50,000%. Home Depot was one of the great success stories of the eighties. It helped define the "category killer" concept for warehouse retailers, and it exploded the market for do-it-yourself home improvement products to the point where it is now a cultural icon.
As the industry leader with 14% of the market, some analysts worry about saturation. Home Depot management apparently isn't worried, planning to nearly double the number of stores to 1,100 by the year 2000. It is also looking to tap into the professional contractor market, a move underscored by last year's acquisition of Maintenance Warehouse/America which targets repair and remodeling pros with its catalogs. They are also adding features to some Home Depot stores to attract professionals such as a separate check-out area (in case they don't want to mingle with the weekend warriors).
The push for professional contractor business and its foray into overseas markets may be critical to the longer-term growth outlook. Home Depot just opened its first South American store in Chile last week, and five more are planned to open by the end of next year. The economic turmoil abroad may limit the overseas potential near-term, but the company needs to find such new venues to expand if it is to sustain the impressive growth in revenues that Home Depot investors have come to know and appreciate. And if it can keep building sales then the profit picture should be gravy, assuming the company succeeds with its shift to self-importing which is supposed to boost margins dramatically.
Earlier this year, Home Depot unveiled a plan to shift away from using third-party importers, a move which could boost gross margins by a stunning 10 to 15 percentage points. That means gross margins would rise from around 28% currently to 38%-43% just by directly importing the goods it sells. Of course, the shift will be gradual. Home Depot currently self-imports 3% of its goods and it plans to increase that to 10% within five years, so this is no overnight, snap-of-the-fingers transition. Nonetheless, the sheer dollar amounts involved are huge--one analyst estimates nearly $1 billion in added gross profits.
As successful as the company is, the stock hasn't always headed higher. After a big run-up in the early-nineties, the stock went flat from '93 to '95 while earnings caught up to the stock price. It wasn't that Home Depot stopped growing, indeed, it continued to chalk up 30%-35% growth in revenues and 25%-30% gains in profits. The stock had simply gotten ahead of what the company could deliver in terms of bottom-line growth. By late-1992, the stock had a Price/Earnings ratio of 86! Over the next three years the stock price went sideways while earnings kept growing 25%-30% a year, bringing the P/E back to the 30-35 area, much more in line with the growth rate. Once that occurred, the stock returned to its upward trend.
At $41.25 currently, Home Depot carries a P/E of 49 times trailing 12-month earnings and 40 times forward (FY98) earnings estimates. That is still well above the 25% growth rate projected by most analysts and the company itself, but that's pretty common for this top-notch stock. Furthermore, the expanding profit margin story is rather compelling. Only time will tell whether the recent market gyrations have run their course or not, but it seems as though for Home Depot fans, everybody loves the dips.
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