The Home Depot (HD) will report third quarter results on Tuesday morning. At least from my perspective, I see upside catalysts for this name. Still this stock fails to behave like a retailer going into a holiday season where the domestic consumer might just be in pretty good shape. Instead, the Home Depot seems to be trading more in line with the struggling housing market. While the Federal Reserve pursues a strategy for normalizing monetary policy, what is obvious to all with a knack for perception, is that credit driven businesses such as housing are being normalized as well.
The caveat there, however is that as sellers become less willing to sell their homes at market prices, they become more likely to improve what they do own. In addition as younger home owners do eventually see home prices reach levels where they might finally be able to play ball, there will be increased demand for everything sold at Home Depot and Lowe's (LOW) . In addition, morbid as it is, natural disasters such as hurricanes and wildfires do increase demand for what chains like these do. Now this may still be an expensive space, and there is still margin pressure being priced in place due to rising input costs. Let's take a look.
Consensus view for the Home Depot's third quarter EPS is for roughly $2.26, with whispers running as much as a nickel higher than that. As for revenue, projections seems to be headed toward $26.26 billion. That number would be good for 5% yearly growth. Let's get back to those rising input costs now. What might be of paramount importance on Tuesday for this name will be margins. Not just for materials and goods imported from elsewhere, not only from the costs of employing so many workers nationally, but transportation costs have been rising as well, and energy prices were moving in a northerly direction for much of the quarter being reported.
I am long some HD shares. My position is much smaller than it once was as in early October, as my panic point of $183 was breached to the downside. The stock has rebounded since, without hitting my secondary panic point of $167. I have been offered a second chance it would seem to rebuild the position close enough to where I sold the shares. What does a trader do? This one is not so easy.
The stock does seem to play along with obvious Fibonacci levels. These shares trade at 18 times forward looking earnings. That makes the name a little expensive for the S&P 500, but also a little cheap for the Consumer Discretionary sector. Total debt is oversized, but cash flow is there, and there is no concern over servicing that debt. You'll notice the very low Quick Ratio. Retailing is the one space where I tend to overlook that slice of fundamental data, as running with large inventories is a necessary evil for the group.
I am likely to remain long the name at my current size (about 20% of what I would consider a full allotment here.) I would rather add on weakness tomorrow than ahead of the report. If we never see that weakness, this is what a trader could do in minimal lots.....
-Purchase one HD November 16th $185 call (last: $3.72)
-Sell one HD November 16th $192.50 call (last: $1.25)
This strategy is known as a bull call spread. The sale of the call with the higher strike partially subsidizes the purchase of the call with the in line strike as a way to sort of hedge the trader's bet. The net debit here is $2.47. Max net profit on the trade after accounting for that math is $5.03. In layman's terms, the trader is risking $2.47 to try to make $7.50.