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Commentary

Big-Ticket Consumer Spending Remains Solid at Home Depot

We’re raising our fair value estimate for Home Depot after the firm logged another quarter of solid growth.

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Wide-moat  Home Depot (HD) logged another quarter of solid comp-store sales growth and operating performance as topnotch merchandising persists despite lingering inventory issues surrounding flow of goods through the West Coast ports. Macro factors provided a mixed bag for the business, with GDP coming in softer than management expected, but housing metrics ticking positively in favor of continued repair and remodel spend. Morningstar estimates call for repair and remodel spending to rise at a mid-single-digit rate through the end of the decade, providing the basis for our mid-single-digit comp outlook for Home Depot and  Lowe's (LOW). We plan to raise our $104 fair value estimate modestly to adjust for a more optimistic home improvement spending picture, but view shares as slightly overvalued at current levels, trading at 22 times the midpoint of management’s updated EPS guidance and implying more aggressive cash flow assumptions than our model calls for.

The better-than-expected results led management to raise its full-year guidance. For 2015, sales are forecast to rise 4.2%-4.8% (from 3.5%-4.7%), comps are expected to tick up 4%-4.6% (from 3.3%-4.5%), helping to deliver earnings per share of $5.24-$5.27 (about a dime higher than prior estimates at the midpoint). We had previously modeled revenue growth of 4.8%, comp growth of 4.5%, and earnings per share of $5.19, at the high end or above prior company expectations, but will be revising these figures upward in response to today's results. In addition, expense growth should be slower than previously expected at 35% of revenue (versus 40%), boosting operating margin potential over the remainder of the year. We can't see much reason to amend our top-line growth down for the remainder of the year in light of the continued strength in the repair and remodel market we expect, which is likely to push our estimates just above the company's outlook in both the revenue and earnings categories.

Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.