Its Not Too Late to Buy Home Depot

Home Depot (NYSE: HD) cheered a market seemingly worried over a Roadrunner like rush over the fiscal cliff. I think it was a timely set of results which served to remind the market that conditions in the US are –albeit slowly and unevenly- getting better. It’s not my intention to make any social comment, but rather try and contribute some information which might help investors make better decisions. In this piece I want to articulate why Home Depot is still a buy in my book and look at the color in these results and see what conclusions can be reached for other stocks.

Home Depot Raises Beats and Raises Guidance

On a reported basis it was a miss but there was an 11c charge for closing stores in China where its idea of establishing big box stores has been deemed a failure. No matter on an adjusted basis it is a pretty handy beat on earnings as well as revenues. Indeed Home Depot raised full year sales growth. I’ll get back to earnings in a moment but for now, here is how it has been adjusting guidance upwards this year. Note the contrast to previous years.

There is an obvious and pleasing progression this year but this is partly an optical illusion. In reality there was a pull forward in sales in Q4 2011 and Q1 2012 which was partly a consequence of the un-seasonally warm weather encouraging more construction activity in those quarters as well as an increase in demand coming from housing repair work created by Irene.

In fact these points are the key to understanding why the market is so excited by Home Depot’s results. In spite of raising guidance, its management was cautious about baking in any assumptions for Q4 from Sandy.  The reason is that much of Irene’s repair work was brought forward by the warm weather and no one has strong idea of what the weather the will be in Q4 this year. However, the repair work due to Sandy is believed to be adding at least what Irene did (around $360m in sales) so analysts will have to start raising assumptions for Q4 and Q1 and this is on top of favorable developments in its end markets due to a nascent recovery in the housing market.

Home Depot Sales Signaling Strength

Looking at the results in more granular detail I think there are two really interesting points.

The first is that Q3 came up against a tough comparable last year and Q4 will do the same. No matter guidance was pretty good for Q4 and this is without any assumptions from Sandy. In addition the start to November was described as being strong. This implies that there is some linearity in its performance. Indeed I have outlined what is happening in the housing market in a recent article linked here. Read if you are looking for pictorial representation of macro data for the housing markets.

Here is how comparable same store sales growth is trending this year.

The second point is that it is starting to see strength in the more discretionary areas of spending. Things like décor, kitchens, indoor paint, gardening, bathrooms, and appliances were cited as having particular strength. In other words it is not just about repair work, the consumer is starting to open up on housing related expenditure. Moreover 33 of its top 40 markets were cited as being in positive territory with the only weakness being in the North East. This is somewhat understandable given tougher comparisons caused by Irene last year. However that weakness is likely to turn into strength soon.

What This Means to the Sector

The only major negative was in tough roofing conditions relating to the comparison with Irene. In contrast with Irene-which had more wind- the damage caused by Sandy is believed to be mainly caused by water. This suggests that Beacon Roofing Supply (NASDAQ: BECN) might not find as much upside as many think following Sandy. I like the stock but am out of it now on evaluation grounds. It will be interesting to see if it can take its intended pricing this year.

On a more positive note if higher ticket white goods are doing well than surely Whirlpool (NYSE: WHR) can expect better things going forward in the US? Europe has now decreased so much in profitability that the US and Latin America are the key to its prospects.  It’s a similar story of strength with a stock like Sherwin-Williams Company (NYSE: SHW) which makes the kind of indoor paints that Home Depot is outperforming in. The stock has had a great run this year but with its heavy weighting towards the US construction market its prospects are likely to get better.

Another two companies worth highlighting are Williams-Sonoma (NYSE: WSM) and Pier 1 Imports Both were up in sympathy with these results and it’s a good call by the market because they depend on relatively lower ticket item discretionary spending in the housing sector. Home Depot outlined that the worst geographic areas of the housing market were now seeing sequential improvements and this broad based strength will surely feed into WSM’s and Pier 1’s top line numbers.

Where Next For Home Depot?

I think the stock goes in the mid and longer term. Analysts will have to raise estimates after these results and given an ongoing recovery in housing there is upside potential to prospects. On current earnings it looks fairly valued so I think it is likely to at least ‘return its earnings’ in the next year or so. This translates to a target price in the low 70’s with upside potential given acceleration in end market conditions. I like this kind of investment.