Has Home Depot Maxed Its Potential?

Home Depot (NYSE:HD) holds the dominant position in the U.S. home improvement industry, accounting for approximately 60% of all revenues.  With 1,977 stores across the U.S., Home Depot has been a one-stop shop for many consumers looking to buy home improvement goods. Although the U.S. economy remained upbeat in 2014 with GDP growing at 2.3% and unemployment hitting record lows at 6%, activity in the housing market remained relatively glum. For one, existing home sales, among the most important determinant for home improvement spending, declined by almost 3% in the full year after having increased by 9.2% in 2013. New home sales also recorded a modest 1.6% rise after having recorded a 16.6% increase the previous year. ^[1] Furthermore, Home Depot also bore the brunt of a massive data breach, which compromised credit and debit card details of close to 56 million customers. Even in the face of this, revenues for the retailer continued to rise and the stock price increased by over 35% since the start of 2014, to record its biggest climb in half a decade. Given this, could Home Depot have maxed its potential? Here are some factors which we think could play out in Home Depot’s favor, to set the stock touching new heights.

Higher Activity In Housing Markets

The U.S. is an important market for Home Depot since approximately 97% of its stores span across the country. While the U.S. economy is expected to continue doing well, with GDP projected to grow at about 3% and unemployment remaining below 6%, higher activity in the housing market could stir home improvement spending. The National Association of Realtors (NAR) projects existing home sales to grow at a rate of 6.4% and 4.1%, in 2015 and 2016, respectively. In spite of this, existing home sales in absolute numbers have not yet reached their pre-recession levels, which is indicative of potential in the years going forward. New home sales are also expected to register a whopping 33% and 27% increase over the next two years, which could further fuel demand for home improvement goods. Additionally, prices of both existing and new homes are projected to increase, with the former growing at a rate of 5.6% and the latter growing at 2.7% in 2015. ((U.S. Economic Outlook: April 2015))

Yet another factor that is suggestive of higher activity in the housing market is mortgage rates. While many anticipated an increase in mortgage rates post the Federal Reserve tapering of QE, mortgage rates actually remained more or less constant, or declined marginally in 2014. Going into 2015, the Thirty-Year Fixed Rate is expected to remain at its 2014 level of 4.2% before reaching 5.5% in 2016. The One-Year Adjustable rate is expected to go up to 2.7% in 2015, from 2.4% presently, before reaching 4.1% in 2016. Hence, the mere anticipation of higher mortgage rates in the future can be expected to further push up housing and home improvement demand in the short run. ((U.S. Economic Outlook: April 2015)) With both the economy and housing markets poised to do well, we anticipate an approximate 25% increase in the market size of home improvement products by the end of the forecast period.

High Growth In Online Business

Next, Home Depot’s online business has been the fastest growing area for the retailer. In 2013, online revenues registered a whopping 53% increase, followed by a 36% increase in 2014. These results were realized in light of better navigation and convenient search capabilities across the retailer’s product offerings to improve efficiency and ease in shopping. Home Depot stands to gain in this realm going forward. For one, Home Depot’s vast network of 2,260+ stores inherently provides them with a competitive advantage to cater to customers who use the Buy Online, Pick-up In Store (BOPIS), Buy Online, Ship to Store (BOSS), and Buy Online, Return In Store (BORIS) programs. Furthermore, Home Depot initiated a pilot program in 2014 where they will deliver orders placed online directly to customers. In this respect, they opened two new direct fulfillment centers in Georgia and California last year, and will add another fulfillment center in the latter half of 2015. These fulfillment centers are expected to hone efficiency at Home Depot, with close to 90% of orders being delivered to customers across the U.S. in less than two days time.

A Focus On Pro Customers To Drive Revenues

Apart from strong macroeconomic fundamentals and a fast growing online business, Home Depot has also taken a number of steps to better cater to Pro customers, who could pull up sales by driving up average ticket sizes. According to Home Depot’s recent earnings call transcript, the retailer has indicated the launch of a number of brands and services to focus on sales to professional customers. For instance, going into fiscal 2015, Home Depot plans to launch a new color center entailing the Behr, Glidden, and the Home Decorators Collection paint brands. Apart from offering a broader selection of products, the new center also aims at enhancing the customer experience by clearly outlining the different paint assortments to bring ease to the selection process. Furthermore, the retailer plans to introduce new products in the tools category that have higher battery life and durability, which could guarantee more efficiency for pros. In terms of new offerings, Home Depot is also set to expand their product line in grills and patio furnishings. ^[2] The launch of the new products, along with efficiency-enhancing moves such as the roll-out of FIRST phones and the initiation of “Home Depot Delivers,” could guarantee better performance among pros going forward. ^[3]

In conclusion, we believe that it could be a while before Home Depot actually loses steam. The company seems to be well on its way to take advantage of a strong U.S. economy and upbeat housing markets. Based on these factors, we expect revenues for the retailer to continue growing at 3-4% until the end of the forecast period.

We have a price estimate of $120 for Home Depot’s stock, which is above the current market price.

Our complete analysis for Home Depot’s stock

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1. U.S. Economic Outlook [↩]
2. Home Depot’s (HD) CEO, Craig Menear on Q4 2014 Results – Earnings Call Transcript [↩]
3. Home Depot: Four Factors To Watch Out For In 2015 [↩]