Wednesday, August 17, 2011

Home Depot Can Put Your Finances on a Strong Foundation

Home Depot (NYSE: HD) went on a wild ride over the last decade. A former CEO, between 2000 and 2007 Bob Nardelli, took Home Depot into a risky business and left it a much weaker company -- departing with a $210 million severance package. But Home Depot's strong earnings report suggests it may be turning around. Is it time to get into the stock?

As I wrote in 2009, Nardelli wrecked Home Depot by cutting costs to the point that its poorly paid store employees lacked sufficient product knowledge to help customers and store shelves lacked the products customers wanted so they walked across the street to competitors. Not only that, but Nardelli pushed Home Depot into the thin-margin wholesale supply business that tanked along with the housing market.

But Tuesday's second quarter 2011 financial report suggests that Home Depot may have better days ahead. Its second quarter net income rose 14% to $1.36 billion and its EPS of 86 cents a share beat by four cents the average of 21 analysts' estimates in a Bloomberg survey. Revenue from Home Depot stores open at least a year rose 4.3% -- 3.3 percentage points higher than analysts' estimates.

And Home Depot raised its guidance. By improving its customer service, due in part to employees use of handheld mobile devices to process inventory coming into stores and help customers find items. Home Depot is doing better than expected. This led the company to raise its fiscal 2012 EPS forecast by 10 cents a share from $2.24 in May to $2.34 -- four cents higher than analysts expected.

This all sounds very promising for investors, but is now the time to buy Home Depot stock? Here are three reasons to consider it:
  • Good quarterly earnings. Home Depot has been able to surpass analysts’ expectations in all of its last five earnings reports.
  • Decent dividend. Home Depot pays an attractive 3.01% dividend yield
  • Home Depot is out-earning its cost of capital. Home Depot is earning more than its cost of capital – but it’s not progressing. How so? It produced no EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first six months of 2011, Home Depot EVA momentum was 0%, based on first six months' annualized 2010 revenue of $72.5 billion, and EVA that rose from $1.6 billion in the first six months' annualized 2010 to $1.9 billion in in the first six months' annualized 2011, using a 9% weighted average cost of capital.
Here are two reasons to hesitate:
  • Expensive stock. Home Depot price to earnings to growth of 1.22 (where a PEG of 1.0 is considered fairly priced) means it is expensive. It currently has a P/E of 14.9 and is expected to grow earnings 12.2% to $2.62 in fiscal 2013.
  • Declining sales and profits -- but less debt-laden balance sheet. Home Depot has been losing sales and profits. Its $68 billion in revenues have fallen at an average rate of 3.8% over the last five years while its net income of $5.3 billion has increased at a 12.5% annual rate -- yielding a solid 8% net profit margin. Its debt has fallen faster than its cash. Its debt has declined at 6.9% annual rate from $11.6 billion (2007) to $8.7 billion (2011) while its cash fallen at a 2.9% annual rate from $614 million to $545 million during the period.
Home Depot looks like it's turned the corner with an effective focus on improved customer service that is bringing the company back to its roots while using the latest technology. The stock is a bit expensive but if it keeps beating expectations, then the current price could look low to those who buy the stock now.


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