Business prospects at home improvement retailer The Home Depot, Inc. (HD – Free Home Depot Stock Report) look bright. The company’s stock price is near an all-time high of around $120. The valuation is being driven by strong results, thanks largely to the ongoing housing market recovery in the United States. Sales in the most recent quarter, ended August 2nd, rose 4.3% compared to a year ago, and would have been higher if not for the strong U.S. dollar. Margins have also expanded due to the higher volumes, along with good cost controls. This allowed share net to jump 9% in the period compared to the year-earlier tally.
Investors interested in this stock should note that we expect Home Depot to continue to post strong top- and bottom-line results, at least through the second half of the year. But there are some risks associated with the stock, including increased competition from online retailers, as well as payment security-related concerns. The question investors should ask is whether the stock is too richly valued at its current price, or can the price continue to rise with the anticipated strong results over the coming quarters. Another question is whether the stock is a good long-term play. We will address these issues by performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
The Home Depot, Inc. is the largest home improvement retailer in the world. As of the end of fiscal 2014 (ended February 1, 2015), the company had 2,269 stores throughout the United States, Puerto Rico, Canada, and Mexico. Each store averages about 104,000 square feet of enclosed space, with roughly 24,000 additional square feet of outdoor garden space. The stores sell a wide array of building materials, home improvement products, and lawn and garden goods. Major product categories include kitchen, indoor garden, paint, outdoor garden, building materials, lumber, flooring, plumbing, electrical, hardware, and bath, among others. It obtains high-quality products directly from manufacturers around the world, and each store typically stocks between 30,000 and 40,000 products during the year. As of the end of fiscal 2014, the company had roughly 371,000 employees. The company was incorporated in 1978 and is based in Atlanta, Georgia. It has been trading on the NYSE since April 19, 1984.
Recognized Brand: As the largest home improvement retailer in the world, Home Depot is the most recognized brand in the industry. The company has the highest sales of any of its competitors. In fiscal 2014, HD reported revenues in excess of $83 billion and net profits of more than $6 billion. Customers, particularly professional ones, tend to go to HD when they are looking for quality products at competitive prices with good customer service. The company has been seeing strong growth in same-store-sales, particularly in the United States, along with higher average ticket prices. Too, the company maintains higher margins than many of its competitors, thanks to management’s tight controls on expenses. This type of financial strength and leadership enables Home Depot to continue to keep customers happy and helps boost investor confidence thanks to its bright prospects.
Diversified Product Mix: As we mentioned above, a typical Home Depot store holds roughly 30,000 to 40,000 different kinds of products, ranging from kitchen appliances and building materials to hardware and home improvement goods, among others. This diversity of offerings allows the company to meet all the varied needs of its customers, so they can do all their shopping at HD instead of having to go to several other stores. The mix also lowers the risk to Home Depot because if, for example, one particularly product category falls out of favor, other product groups can help pick up the slack.
High Debt Levels: Home Depot has maintained high debt levels in recent years. As of August 2, 2015, the company had $16.3 billion in debt on its balance sheet, representing about 65% of total capital. In fiscal 2014, revenues rose by 6%, but debt increased by 15%. The interest payments associated with this debt will continue to pressure earnings in the near term. High debt levels can also limit expansion plans and make it difficult to raise funds from investors at favorable terms.
Dependence on the American market: In fiscal 2014, the United States accounted for roughly 90% of total revenues for the company. This dependence on the U.S. market makes it vulnerable to downturns in its economy. The remaining 10% of revenues aren’t geographically diverse either, with the remainder of sales primarily coming from Canada and Mexico.
Global Expansion: While Home Depot has been doing a good job expanding its retail market in the United States, particularly with the recent acquisition of Interline Brands and an agreement with HD Supply to acquire its Hardware Solutions business, the company has still not made any inroads in other major international markets. Management appears more focused on strengthening same-store sales than on opening up new stores abroad. The company pulled out of the Chinese market last September, with CEO Frank Blake stating that, while China is a great market, the company didn’t really have an answer for understanding the needs of that market and how it could use its distribution strength to provide them better value. This is an area that needs to be addressed, because whether an expansion occurs in China, Europe, or South America, it could provide huge opportunities.
Online Retailing: Home Depot has been working to improve its online presence, and it has paid off. In fiscal 2014, the company had over 1.2 billion visits to its online properties, and sales from its online platforms rose 37% from a year earlier and represented nearly 5% of total revenues for the year. Management has beefed up its ability to deliver orders placed online, and we expect this business to continue to expand. It opened two direct fulfillment centers last year, and another is on the way this year. Millennials are clearly an important target for the company and the way to attract them is through online offerings, as they are more likely to shop around for products online.
Competition: While Home Depot remains the largest home improvement retailer in the world, it still faces stiff competition from several major companies. In every market it serves, there are a number of other home improvement stores, electrical, plumbing, and building materials supply houses and lumber yards. Specialty design stores, discount stores, local, regional, and national hardware stores also compete for business. Online and multichannel retailers are also becoming increasingly competitive. Home Depot’s primary competitor is Lowe’s (LOW). Other competitors include general merchandise retailers like Wal-Mart (WMT – Free Wal-Mart Stock Report) and online retailers like Amazon.com (AMZN) that offer home improvement products. Competition may force the company to lower prices and increase marketing and promotional expenses, which would likely hurt margins and the bottom line.
Online Theft: In September of 2014, the company confirmed that its payment data systems had been breached, which impacted customers who used cards at its U.S. and Canadian stores. An intruder accessed payment card information on up to 56 million customers in North America who shopped between April 2014 and September 2014. 53 million email addresses were also taken during the breach. While management has taken steps to improve its payment data systems, including a major security project that provides enhanced encryption of this data at the point of sale in all U.S. stores, further data breaches would no doubt spook customers and could hurt sales if they don’t feel comfortable providing their credit card information. The additional costs of cyber security spending could increase operating expenses, as well.
Home Depot will likely continue to be the largest player in the home improvement products industry for many years to come. Its sales are nearly one-and-a-half times that of its nearest competitor, Lowe’s. Margins should continue to widen, thanks to stronger sales in North America and improved operational efficiency. However, the risks to its business should not be overlooked. The company’s reliance on the North American market leaves it susceptible to economic downturns here, particularly in the housing market. Another major security breach could also spook investors and cause the stock’s price to fall. Nevertheless, we view Home Depot as a sound investment overall. The stock is relatively safe, offers a solid dividend yield of around 2%, and has room for price appreciation given its bright outlook. Over the longer term, the company will need to address some of the aforementioned issues, including its lack of a global presence, to drive earnings growth in the years to come. Subscribers interested in learning more about Home Depot should check out our full-page report in The Value Line Investment Survey.