M. Suhail
Home Depot (NYSE:HD) is set to report its earnings before the market opens on Tuesday, November 15th. If we look at some of its smaller peers and suppliers, things have slowed down in the last quarter and this trend is expected to continue in the near future. Below are some of the relevant excerpts,
“… our view is as things get tougher, we’re going to see a deceleration comp and almost all of that driven by transactions.”
Q3 earnings call commentary by Trevor Lang, Chief Financial Officer, Floor & Decor (FND)
“During the quarter, we saw a softening in U.S. single-family new construction and R&R as the Federal Reserve’s continued action on interest rates started to have its intended effect on housing demand.”
Q3 earnings call commentary by Nicholas Fink, Chief Executive Officer, Fortune Brands (FBHS)
“Moving on to the overall demand picture. POS and incoming orders slowed more than expected late in the third quarter across most of our product categories, and we anticipate this slowdown to continue into the fourth quarter.”
Q3 earnings call commentary by Keith Allman, President & CEO, Masco (MAS)
So, I expect a similar commentary around slowing macros from Home Depot as well. However, the good news is that investor expectations are already low and there are some indications that inflation might start cooling down, especially if we look at the latest CPI data. While it is never wise to extrapolate one single CPI data point, there is good logic behind my expectation of moderating Y/Y inflation and I did predict the cooling down of inflationary pressures in an article on AT&T (T) last month based on it. Below is the relevant commentary from that article,
If one looks at the U.S. CPI, it was hovering near mid-single-digit percentage growth Y/Y in the middle of 2021 and then it started accelerating from October and reaching high-single-digit percentage increases Y/Y in December 2021. So, if we think about the percentage increase in Y/Y CPI looking forward, it should moderate over the coming months due to tough comparisons. Further, the supply chain constraints, which were one of the main drivers of inflation, are also easing. This should also help bring down the inflation numbers in the coming months. Once concerns around inflation ease, expectations around high-interest rates continuing for a long will also moderate.”
Home Depot’s stock has seen a sharp run-up since the CPI data was released. Since it will likely take several quarters before interest rate hikes actually start getting reversed, I am not expecting management to be too excited about it and share any positive commentary based on CPI data alone.
However, I do expect a positive commentary by management on the near-term increase in demand for repairing and remodeling arising from the destruction caused by Hurricane Ian in September. From the medium to long-term perspective, the company should also benefit from its investments in increasing Pro capabilities over the last few years, and management should share more details about it on the earnings call.
The company started a multi-year investment in strengthening its Pro capabilities in 2017 which should be substantially complete by the next year. The company has invested in various initiatives like flatbed distribution centers, direct fulfillment centers, and market delivery operations for big and bulky goods. This positions the company well to serve Pro customers. The company’s capabilities to deliver large quantities of materials directly to the job site is helping it gain market share in planned purchase opportunities with the large Pro customers. According to management, Home Depot’s success with these planned purchase opportunities is still in the initial stages, and they expect continued share gains from regional independents and nationwide building material suppliers. HD started its first flatbed distribution center (FDC) almost two years ago in Dallas and now it has FDCs in other markets like Atlanta, Miami, New Jersey, and Baltimore.
I believe management’s commentary around the expansion of FDCs to the west coast markets and other initiatives in the next year, and how much growth the company can generate from Pro market share gains over the coming years, should be critical for the stock price and closely watched by investors.
Other than these initiatives, the company’s acquisition of HD Supply a couple of years back has also opened an opportunity for it in the maintenance, repair, and operations (MRO) submarket of Pro space. The company already had good exposure to MRO-related business of multifamily housing earlier, however, with the HD Supply acquisition, the opportunities in the new verticals like hospitality, healthcare, government, university dorms, etc., have also opened.
I believe the company’s secular share gain prospects in the Pro segment should offset the macroeconomic slowdown in FY23. Hence, I am expecting an upbeat commentary for FY2023 by management.
If we look at the consensus estimates, the sell-side is expecting the company to grow its revenues and EPS in the next year (albeit at a slower pace) despite macroeconomic concerns next year. According to some sell-side analysts, Home Depot is placed slightly better to weather macro headwinds and beat estimates, compared to Lowe’s (LOW), given its higher Pro exposure. So, I am optimistic about HD’s stock prospects given already low expectations and further market share gain opportunity in Pro, which should offset macroeconomic headwinds. The stock is also attractively valued at 18.97x FY23 consensus EPS estimates and 18.32x FY24 consensus EPS estimates, which is a discount versus its 5-year average P/E (forward) of 21.51x.
While I expect the company to talk about the slowing macro environment and consumer demand in the near term, this is already well-known and expected. The company’s commentary around Pro share growth and how it will offset the macro slowdown and drive long-term growth should be much more closely watched by long-term investors. So, even if there is a decline in the stock price due to near-term woes, it should be a buying opportunity for long-term investors. Hence, I am optimistic about the company’s prospects and have a buy rating on the stock.
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