What Is Home Depot’s Fair Value?

Home Depot (NYSE:HD) has reported solid revenue and earnings growth through the first nine months of the year, driven by the robust growth of its digital segment, coupled with marked improvement in the housing market. In addition to strong growth in the top line, the reduced effective tax rate helped the company post better than expected earnings in the first nine months of 2018. Despite this, the stock fell by roughly 10% year to date – as a result of sub par Q1 performance and cautious full year guidance. We expect the company to benefit in the near term as a result of the aforementioned trends. However, higher than anticipated transportation costs should slightly dampen this outlook. Nevertheless, Home Depot’s continued investments to bolster its supply chain to counter this should drive decent medium term growth.

We have a price estimate of $210 per share for the company, which is slightly higher than its current market price. View our interactive dashboard – Home Depot’s Outlook For 2019 – and modify the key drivers such as revenue and margins to gauge the impact on the company’s valuation.

Factors That Should Impact Performance

1. Potential of Housing Market: Home Depot has continued to benefit despite news regarding a weak housing market. The company saw its revenues grow by just over 6% in the first nine months of 2018, as more homeowners preferred to remodel their homes rather than selling. The company has often stated that the housing stock in the country is old and in need of repair and renovation, which should further help Home Depot. Accordingly, the company feels positive about the strength in the home improvement sector. Moreover, unemployment is at its lowest level since 2000, and wages are improving. Although interest rate hikes make mortgages more expensive, on the whole, it is indicative of a strong economy. Strong macroeconomic conditions bode well for a company like Home Depot that is heavily reliant on the improvement of the economy.

2. Pro Sales Outpacing DIY Sales: The company’s Pro-segment is a key driver of its growth, with Pro-sales outpacing the sales of the DIY segment. Therefore, a focus on this segment is crucial for ensuring future growth. Pro-segment sales have consistently improved above the company average in the first nine months of 2018. Home Depot has been increasing its investments to deepen its relationship with such customers, including enhanced associate tools in the stores and expanded delivery options. For example, in the case of the latter, the company has started two-hour and four-hour deliveries in some markets. HD’s big-ticket transactions, those above $1000, form nearly 20% of their U.S. sales.

3. Interconnected Retail Strategy: Home Depot has been persistently focusing on creating a truly integrated retail strategy, which seamlessly connects online and offline channels, in a bid to enhance the shopping experience and improve store efficiency. As a result, the company witnessed improved revenues and profitability. Further, Home Depot’s digital segment has seen robust growth in the first nine months of the year mainly due to increased online traffic. Moreover, in the digital space, the typical transaction ticket size is three times of that in a store. By focusing on the truly interconnected channel strategy, Home Depot has been able to boost revenues per square foot, rather than generating revenues from new square footage. This has ensured that its present store network is being efficiently used to drive revenues.

4. Higher Ticket Size: Multiple factors have resulted, and should continue to benefit, the average ticket size. Apart from the above mentioned factors such as greater pro-sales and growth in digital sales, the focus on appliances, as well on innovation, are other factors driving this increase. Greater investment into appliances has resulted in share gains, with appliances garnering a higher than average ticket size. An example of innovation is the use of lithium technology in outdoor equipment, such as the lithium lawnmower, which is priced at $500, as compared to one that runs on gas, which typically costs between $200 and $300.

5. Higher Transportation Costs: The company faced transportation headwinds throughout the first nine months of 2018. The higher costs resulted in a 23 basis points negative impact on the gross margins in Q3, following on from the 16 bps and 8 bps contraction from this in Q2 and Q1. While Home Depot isn’t the only company facing higher transportation costs, the increasing shift toward the online space, as well as the addition of features such as same-day delivery, can put pressure on the gross margins through the financial year. Consequently, the company expects gross margin to improve 37 bps this year, down slightly from the previous guidance of 44 bps.

6. Supply Chain Investments: HD plans to invest roughly $1.2 billion into its supply chain over the next five years to significantly enhance its supply chain infrastructure. Given the growing retail landscape, the company believes “a great customer experience depends on great supply chain capability.” Over the past decade, the company has made big strides in its upstream supply chain – moving product to the stores and direct fulfillment centers (DFCs) – and more recently, it has undertaken significant expenditure to build its downstream supply chain – delivering to customers directly. However, the home improvement giant feels there is still some way to go to fully leverage its upstream network, as well as build the fastest and most efficient delivery system. In this regard, some of the steps being undertaken by the company include adding 170 distribution facilities across the U.S. to reach 90% of the U.S. population in one day or less, opening 40 flatbed direct fulfillment centers to serve HD’s top 40 markets, and continuing the rollout of van and car delivery options in top urban markets in the near term.

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