Home Depot Q3 Earnings: Doing The Best It Can Against All Odds
Contributor since 2021 / 742 Followers
Summary:
- Home Depot’s Q3 performance exceeded expectations, driven by hurricane-related sales and the integration of SRS Distribution, leading to an upward revision of FY24 guidance.
- Despite positive Q3 results, high interest rates and elevated mortgage rates continue to defer larger remodeling projects, posing a significant headwind for Home Depot’s growth.
- The SRS acquisition appears promising, contributing significantly to sales and aligning with Home Depot’s strategy to emphasize the Pro segment, though its full impact will take time.
- Given the current valuation and macroeconomic challenges, I maintain a HOLD rating on Home Depot, as the stock shows little-to-no upside potential at current levels.
kieferpix
Investment Thesis
In my last article on Home Depot (NYSE: NYSE:HD), published in May 2024, I analysed the company’s first quarter report and investigated how the company’s renewed strategy of focusing more on the Pro business was progressing. I also dissected the implications of the company’s planned acquisition of SRS Distribution (this acquisition has now closed). I had a HOLD rating on the stock.
Since the article was published, the company’s stock has gained 19.7%, handily outperforming the S&P 500, which gained 10.65% during the same period.
In this article, I analyse the key takeaways from the company’s Q3 report and now that the acquisition of SRS has been closed, I also dissect the future impact from the acquisition on the company’s long-term growth.
A Snapshot of HD’s Third Quarter Performance
Home Depot had a strong third quarter, especially when one factors in the challenging macroeconomic backdrop that it had to operate in. Q3 revenues came in at $40.2 billion, up 6.65% y/y and comfortably beating analyst estimates by $898.2 million. Adjusted Diluted EPS of $3.78 also beat analyst estimates by $0.12 despite being down 1.8% y/y. Comparable sales came in much better than street estimates, as evidenced by the actual decline being 1.2% compared to expectations of a decline of 3.3%. Customer transactions and average ticket both declined marginally, by 0.2% y/y and 0.8% y/y respectively.
As a result of a stronger-than-expected third quarter performance, management revised their FY24 guidance upward. Full-year revenues are now expected to grow approximately 4% y/y and comparable sales are now expected to decline only by 2.5% compared to the previous guidance of a decline in the range between 3% and 4%. The adjusted Diluted EPS for the 53-week year is now expected to decline approximately by 1%, which translates to $15.10, of which $0.30 is contributed by the 53rd week. The 53rd week is also expected to add approximately add $2.3 billion to the total sales, and now that the company has closed its acquisition of SRS, an additional $6.4 billion is expected to be added to the sales from SRS for the full year. The company left its quarterly dividend unchanged at $2.25 per share, which translates to a forward yield of 2.2%.
Powell and Yields Put a Cap on HD’s Growth Potential For the Foreseeable Future
A lot of things went right for HD in the third quarter, which resulted in a better-than-expected performance. First, the impact of the two hurricanes, Helene and Milton, contributed to incremental sales. The hurricane-related sales amounted to approximately $200 million, boosting the company comps by approximately 55 bps for the quarter. The company also expects hurricane-related demand to spill over into Q4, although the contribution won’t be as strong as in Q3. Furthermore, a more favourable weather in other regions contributed to improved sales for the company’s outdoor category. These external factors led to several categories such as power and outdoor garden posting positive comps, whereas the likes of lumber, plumbing and hardware all posted sales above their average. In addition, holidays such as Labor Day and Halloween also boosted sales. The better-than-expected third quarter performance, as a result of the aforementioned factors, led the company to even boost its full-year guidance.
Despite these positive developments, there has been no change to the major headwind for the company, which is the continued deferment of larger re-modelling projects due to “higher interest rate environment and continued macroeconomic uncertainty.” And the issue, in my opinion, is that this is unlikely to change anytime soon, although the landscape has definitely improved compared to the start of the year thanks to the Fed starting its rate-cut cycle.
If HD’s management was hoping for a speedy return to normalization of rates, then last Thursday, Fed Chair Jerome Powell poured cold water on those hopes when he claimed that the US economy was “not sending any signals” that requires the Fed to “be in a hurry to lower rates.” In other words, the US economy is, likely, to be in a higher rate environment for a longer period than previously anticipated. Chair Powell’s comments also did not factor in any potential inflationary impact from President-elect Trump’s prospective tariffs, which could further slow down the Fed’s rate cutting cycle. And this is not good news for HD, whose management, during the Q3 earnings call, warned multiple times that as long as rates continue to remain at current levels, the higher-priced re-modelling projects would be deferred.
Adding to this problem is the elevated mortgage rates, which have adversely impacted the existing home sales. Existing home sales in October fell 1% to 3.84 million units, after adjusting for seasonality, which is a 14-year low. They also came in below economists’ estimates of 3.86 million units. Economists continue to expect housing market activity to remain subdued well into 2025 and there are reasons to support this case. The issue is that mortgage rates are tied to Treasury yields and not to the Fed’s rate-cutting cycle. And yields have been jumping ever since the results of US elections, on the impression that President-elect Trump’s campaign promises of tax cuts and tariffs would put pressure on prices. Should they continue to rise, then one can expect mortgage rates to do the same, which would subsequently have a negative impact on home sales. This was yet another issue raised by HD’s management, and in my opinion, investors should listen to these warning signs, as it could mean the company’s growth may not pick up until well into FY25.
Overall, it may have been a solid quarterly performance by HD, but keep in mind that they were primarily driven by one-off factors. When one looks at the big picture, however, especially with respect to areas that really need to improve for HD to experience growth again on a consistent basis, then one would see that the headwinds for those areas are likely to last longer than initially anticipated.
SRS Acquisition Looks Promising Based on Q3 Performance
The last time I wrote about HD, I mentioned how the company’s largest acquisition in history, SRS Distribution will take time to pay off, even though strategically, it is the right move. Q3 was the first quarter that reflected the full impact of the SRS acquisition, now that the deal has been closed. And based on the Q3 numbers and the guidance offered by the management, the acquisition appears to have paid off. SRS, which operates in the Speciality Pro segment, is on track, according to HD management, to deliver $6.4 billion in sales from the period the deal was closed. The positive contribution from SRS led the HD management to boost its revenue guidance.
Having said that, investors need to give this acquisition more time to fully see the impact on the company’s long-term growth. HD’s management did offer some anecdotal evidence as to how the acquisition can boost the company’s future growth prospects. For instance, CEO Ted Decker mentioned during the earnings call that the company is “seeing incremental cross-selling opportunities from our distinct product catalogues and competitive advantages.”
As mentioned in my previous article on HD, the specialty trade contractors’ market is expected to grow at a CAGR of 6.7% and reach $7.9 trillion by 2028 globally. Furthermore, one of the key takeaways from the third quarter was that ‘needs-based projects’ are seeing momentum and have not seen any slowdown. Such projects tend to skew towards the Pro segment, which is good news for HD, especially now that SRS has been integrated into the company.
The last time I wrote about HD, I did warn investors not to put too much emphasis on the SRS deal until there is more evidence. While these are still early days, in my opinion, the acquisition remains on track to provide a strong tailwind to the company’s growth story.
Valuation
|
Forward P/E Multiple Approach |
|
|
Price Target |
$413.00 |
|
Projected Forward P/E multiple |
26.4x |
|
Projected FY24 EPS |
$15.10 |
|
Projected Earnings Growth Rate |
3.65% |
|
Projected FY25 EPS |
$15.65 |
Sources: LSEG Data (formerly Refinitiv), HD’s Q3 Earnings Report, Seeking Alpha and Author’s Calculations
The company, as mentioned earlier, projects the 53-week adjusted diluted EPS to decline by approximately 1%, which translates to $15.10, which is a reasonable estimate in my opinion. It is lower, however, than my previous estimate of adjusted diluted EPS of $15.26.
The company currently trades at a forward P/E of 26.4x, which is significantly higher than its historical forward P/E multiple of 21.6x (5-year median) and 20.4x (10-year median). However, given that its peer LOW currently trades at 21.5x and has always traded at a discount to HD, it is clear there has been a re-rating of the sector. As such, I have assumed a forward P/E of 26.4x for my calculations, higher than my previous estimate of 20x.
The company, according to Seeking Alpha, currently trades at a forward PEG ratio of 6.31, significantly higher than its own 5-year average of 3.13 and well above the sector median of 1.62. At a forward P/E of 26.4x, assuming a forward PEG ratio of 6.31 would result in an earnings growth of 4.2%. This is a high estimate in my opinion for multiple reasons. First, this growth rate is higher than its long-term mean growth of 3.65% and in this current environment, despite the company having performed better-than-expected, this growth rate is not justifiable in my opinion. Second, as mentioned earlier, while the Fed has started to cut rates, the recent commentary suggests that they are in no rush to keep cutting rates, which suggests that we might not get a rate cut every quarter. During the earnings call, management did say that the primary reason behind customers putting off purchasing big-ticket items is the high-rate environment. Since we might be in a high-rate environment for longer than previously anticipated, consumers are likely to delay their plans of big-ticket purchases, which implies a delay in the pickup of EPS growth. Finally, the mortgage rates continue to remain elevated as a consequence of rising Treasury yields. In September, existing home sales fell to a 14-year low and median existing home prices rose 3% y/y. These factors are also significant headwinds for HD. Taking all these factors into account, I have assumed FY25 earnings growth to be its long-term mean growth of 3.65%. At this growth, FY25 adjusted diluted EPS is expected to come in at $15.65, slightly lower than my previous estimate of $15.72.
At a forward P/E of 26.4x and a projected FY25 adjusted diluted EPS of $15.65, the new price target becomes $413, which implies little-to-no upside from Friday’s closing price. Furthermore, the company has a B+ grade on Seeking Alpha’s Momentum metric, which is good but not strong. As such, despite bumping my price target from $314, which was set 6 months ago, I am maintaining my HOLD rating on the stock.
Concluding Thoughts
Home Depot had a much better-than-expected third quarter, driven primarily by the incremental sales from hurricanes Helene and Milton. It was also the first quarter post the integration of SRS, and early signs suggest that the acquisition is on track to be a strong catalyst for the company’s revamped strategy of placing a greater emphasis on the Pro segment.
However, HD’s main headwind of consumers deferring the larger re-modelling projects until the interest rates normalize. The issue is that based on the recent comments made by Fed Chair Powell, the Fed is in no rush to cut rates, which means that this headwind could persist for a lot longer than initially anticipated. Moreover, mortgage rates continue to remain elevated courtesy of rising Treasury yields, which has put pressure on home sales. Unless both these elements normalize, HD is expected to face pressure, which in my opinion, could persist well into FY25.
From a valuation perspective, there is little-to-no upside at current levels. HD has done its best to navigate through this challenging macro backdrop and has also made some positive strategic moves. However, given that the landscape has barely changed, the company, in my opinion, is likely to be stuck in first gear for the foreseeable future.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.