Home Depot Building Stock Upside Through Maintenance & Repair Strength

Home Depot (NYSE: HD) is the world’s biggest retailer of home improvement products, and primarily competes with Lowe’s (NYSE:LOW) in the business. Home Depot boasts 2,244 stores spanning across the US, Canada, Mexico and China and offers a wide range of home improvement products and installation services to both individual home owners and professional builders.

We estimate that Home Depot’s Plumbing, Electrical, & Kitchen segment is the single largest value driver of the company’s operations, generating close to 31% of our estimated stock value for Home Depot. We currently maintain a $36.65 price estimate for Home Depot stock, roughly in line with market value.

3% Upside – Repairing Market Share in Plumbing, Electrical, and Kitchen Segment

The company reported strong results last month for its fiscal third quarter, with comparable store sales for the quarter increasing by 1.4% year-over-year (YOY). This reflects the fourth consecutive quarter of same store sales growth for the company’s businesses. ^[1]

In particular, the company reported that particular strength from maintenance and repair, as customers showed their willingness to spend in order to maintain their investments in their homes. Maintenance and repair, which is largely reflected in our Plumbing, Electrical & Kitchen division for Home Depot,  includes categories such as sealers, plumbing repair, fasteners, and water heaters.

We estimate that Home Depot’s Plumbing, Electrical, & Kitchen market share declined roughly 140 basis points between 2005 and 2007 (to 21.4%) before stabilizing at roughly 22% in the years since. We anticipate a modest increase in the company’s market share going forward, to 23% by 2017. However, given Home Depot’s strong performance during its fiscal 2010, our forecasts could prove conservative. Company management now expects fiscal 2010 sales up 2.3% for the year, with fiscal 2011 comparable store sales increasing in the low single digit range. ^[2]

Growing demand for maintenance and repair items alongside an improving economic outlook and increasing comparable store sales could generate upside to our current price estimate. If Home Depot’s Plumbing, Electrical, & Kitchen market share can reach 25% by 2017, it would present a 3% upside to our $36 price estimate.

Drag the trend-line in the chart below to see the impact of various Plumbing, Electrical, & Kitchen market share scenarios on Home Depot’s stock value.

6% Upside – Operating Margins Stabilizing After Significant Drop

We estimate a significant drop in Home Depot’s Plumbing, Electrical, & Kitchen segment operating margins between 2006 and 2008, as the segment’s profit margin, once approaching 14%, fell below 9%. Since then this metric has recovered and we now project stabilization between 10% and 11% going forward, as improving sales faces a headwind of increasing competition from Lowe’s. However, if improving sales trends allow Home Depot to restore profit margins in this segment halfway back to 2006 levels (to about 12%), there could be an additional 6% upside to our price estimate.

Drag the trend-line in the chart below to see the impact of various Plumbing, Electrical, & Kitchen EBITDA profit margin scenarios on Home Depot’s stock value.

See our full analysis of Home Depot here

Notes:

1. See: Home Depot Third Quarter 2010 Results [↩]
2. See: Home Depot Fiscal 2010 Guidance and Fiscal 2011 Outlook [↩]