Reflections – short quantitative analysis of Home Depot (HD)

“The Home Depot, Inc. (The Home Depot), incorporated on June 29, 1978, is a home improvement retailer. The Company sells an assortment of building materials, home improvement products, and lawn and garden products, and provides various services. The Home Depot stores averaged approximately 104,000 square feet of enclosed space, with over 24,000 additional square feet of outside garden area, as of January 29, 2017. The Home Depot stores serve three primary customer groups: do-it-yourself (DIY) customers, do-it-for-me (DIFM) customers and professional customers. The Company had approximately 2,278 stores located throughout the United States, including the Commonwealth of Puerto Rico and the territories of the United States Virgin Islands and Guam, Canada and Mexico, as of January 29, 2017.”

-Reuters.com

• HD beat its closest competitor, Lowe’s (LOW), in nearly all areas
  • Better Profitability Ratios:
    • Higher profit margins due to lower relative expenses (and higher relative returns)
    • Higher ROE due to lower reliance on equity to fund investments (notice that Debt-to-capital ratio is 0.95 which reflects high reliance on debt as compared to equity in funding projects)
  • Better Activity Ratios
    • More efficient in converting assets into revenue
  • Better Liquidity Ratios and better Coverage Ratio
    • More able to pay off their debts using current assets
    • More able to cover interest expenses using EBIT
  • Worse Debt Ratio
    • Huge amount of liabilities relative to LOW
    • Mainly because HD relies more on debt rather than equities to fund projects (as seen from high Debt-to-capital ratio)

• Strong dividend growth track record
  • Current dividend yield of 2.32% ($4.12/$177.44)
  • 10year average annual dividend growth = 17%
  • 3year average annual dividend growth = 23.8%
  • Low dividend payout ratio (using Net Income) at 48.8% ($4212m/$8630m)
• BUT expensive price of shares relative to valuation based on growth
  • Current price of $177.44 is 41.2% premium to intrinsic value based on simple Valuegrowth model (assuming zero future growth)
  • Using simple DCF analysis, assuming values of 8%, 6%, and 4% for growth after first 2 years, next 3 years, and terminal growth, valuation as follows
  • Current PE ratio of 24.3 which is expensive relative to earnings (EPS=$7.29)
• Fair valuation based on dividend growth potential
  • Use past year dividend value of $3.56 to estimate
  • Using Gordon constant growth dividend discount model, assuming discount rate of 10% and constant future dividend growth rate of 8%, we get a valuation of $192.24 per share ($3.56*1.08/(0.1-0.08))
  • Using Two-Stage dividend growth model, assuming discount rate of 10%, initial dividend growth rate of 23% for the next 2 years, and a 7% terminal growth rate, we get a valuation of $190.90 per share

Verdict

• Despite strong fundamentals of company and stellar historical growth track records, price of shares very expensive as compared to valuations. Might initiate small position in company to take advantage of dividend growth but will wait for correction before initiating a full position in the company.