Home Depot (HD) reported lower than expected earnings results for their fourth quarter. While I don't give much concern to estimates as much I do the general trends of the company, I do have concerns over Home Depot's debt levels, the general valuation of their stock, and the slowing housing market. I think this stock topped out when it was trading in the $210-$220 range. The dividend isn't high enough, and the earnings just aren't there to justify a bull case.
Fourth quarter revenues increased 10.9% to $26.49 billion year over year. That's very impressive growth. Gross profits increased an even better 11.5% to a little over $9 billion. Operating income increased 5.9% year over year to $3.38 billion. Net earnings increased 31.8% to $2.34 billion. That income breaks down to $2.09 per diluted share, a 37.5% increase year over year.
If you weren't aware of analyst estimates, these are by all accounts great numbers. So why am I bearish on Home Depot? The answer lies with guidance, and the economics of their consumer.
Based off Fiscal 2018's full year diluted earnings of $9.37, HD stock is trading at around 20x earnings (at the time of this writing). On a forward earnings basis, Home Depot did not provide guidance that inspires confidence in 2019. The company forecasts diluted EPS growth of 3.1%, translating to earnings of $10.03 per share. That growth rate pales in comparison to years past. Between 2015 and 2018, HD's average increase in diluted earnings was 18.09% per year. This new guidance is much weaker than the double digit norm. It would also mean HD is currently trading at 18.3x its forward earnings guidance. That's very close to the historical range, and doesn't leave much room for upside.
I believe the lackluster guidance is in large relation to a seemingly weaker economic outlook for housing. Rates may not have risen much, but they do affect things. News came out today that housing prices increased in December at the slowest pace since 2015. There's much to be looked at here in relation to Home Depot. The retailer has benefited greatly from home values inducing owners to renovate. As the foreseeable increase in value for their dwellings diminishes to fall in line with actual demand, the appeal of spending money on that asset declines. Why renovate your bathroom if it won't add any more value to your house? If that logic becomes a cumulative trend, it hurts the types of goods that Home Depot deals in.
There are naturally a myriad of opinions on the condition of the housing market. This includes analysts, buyers, firms, and everyone in between. Regardless of your view, the reality is that home sales are declining. You can debate the causes and effects, but it is happening. To that end, I don't see a lot of appeal in stocks related to the industry.
The biggest problem with Home Depot is the relationship between growth needs related to its long term debt. The company has accumulated so many liabilities that the stock couldn't handle a downturn. The company has long term debts of over $26.8 billion. Spending dipped the company's cash position by 50% last year to $1.78 billion. That decrease in cash has created an equity deficit on the balance sheet of $1.88 billion. Cash/equivalents decreased by $1.79 billion on the cash flow statement. So as Home Depot is creating growth, they're also spending a lot of money. The problem with the stock is that a slowdown doesn't leave the company a lot of wiggle room. To find good news you have to rely on the income statement. Their balance sheet is not the greatest, nor is their statement of cash flows. This creates risk that doesn't show up when simply looking at quarterly earnings growth.
I'd rate the stock as a "Hold", but the dividend simply isn't strong enough at 2.2% to justify the situation. Home Depot has to maintain robust growth as a hedge against the big debts. I wouldn't invest in a small business with that kind of debt. I don't see any reason to invest in a massive business with that kind of debt.
