February 26, 2015 The Home Depot, Inc. Current Recommendation Earnings Update: Home Depot Tops Q4 Earnings & Revenues, Guides FY15 SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 05/20/2008 Current Price (02/25/15) $116.31 Target Price $122.00 52-Week High $116.75 52-Week Low $75.70 One-Year Return (%) 43.98 Beta 1.03 Average Daily Volume (sh) 5,628,345 Shares Outstanding (mil) 1,318 Market Capitalization ($mil) $153,276 Short Interest Ratio (days) 1.86 Institutional Ownership (%) 72 Insider Ownership (%) 0 Annual Cash Dividend $1.88 Dividend Yield (%) 1.62 5-Yr. Historical Growth Rates Sales (%) 4.9 Earnings Per Share (%) 23.1 Dividend (%) 18.3 using TTM EPS 25.4 using 2015 Estimate 22.4 using 2016 Estimate 19.4 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Risk Level * (HD-NYSE) Home Depot retained its trend of reporting positive surprise for the fourth consecutive quarter gaining from the recovery in the U.S. housing market and strength in core store activities. The company also provided an encouraging guidance for fiscal 2015, despite a strong U.S. dollar. Moreover, we expect Home Depot s focus on developing merchandising tools and increasing investment in e-commerce to boost its top line and increase market share. We also believe that the company is on track to achieve its long-term dividend payout, share repurchase and return on investment targets. However, we remain slightly cautious about the stock due to intense competition from specialty stores and mass retailers as well as impact of soft economic recovery on discretionary spending. Thus, we retain our long-term Neutral recommendation on the stock. Below Avg., Type of Stock Large-Growth Industry Bldg Prd-Rt/Whl Zacks Industry Rank * 93 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) 2013 19,124 A 22,522 A 19,470 A 17,696 A 78,812 A 2014 19,687 A 23,811 A 20,516 A 19,162 A 83,176 A 2015 20,685 E 24,671 E 21,415 E 19,798 E 86,569 E 2016 90,036 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) 2013 $0.83 A $1.24 A $0.95 A $0.73 A $3.76 A 2014 $1.00 A $1.52 A $1.15 A $1.00 A $4.58 A 2015 $1.15 E $1.71 E $1.29 E $1.04 E $5.19 E 2016 $5.98 E Projected EPS Growth - Next 5 Years % 16 (Note: Qtly. Fig. may not add up to annual fig. due to rounding off) 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
RECENT NEWS Home Depot Tops Q4 Earnings & Revenues, Guides FY15 Feb 24, 2015 Backed by the U.S. housing market recovery and strength in core store activities, The Home Depot Inc. ended fiscal 2014 on a positive note with better-than-expected bottom-line results in all four quarters. The company s fourth-quarter fiscal 2014 adjusted earnings of $1.00 per share jumped nearly 37% from the year-ago quarter and surpassed the Zacks Consensus Estimate of $0.89. Including one-time items, the quarterly earnings surged 43.8% year over year to $1.05 per share. Quarterly Details Net sales advanced 8.3% to $19,162 million from $17,696 million in the year-ago quarter, beating the Zacks Consensus Estimate of $18,672 million. The company s overall comparable-store sales (comps) increased 7.9% while comps in the U.S. stores grew 8.9%. Gross profit in the quarter improved 8.6% to $6,723 million from $6,192 million in the comparable yearago quarter, primarily driven by higher sales. Gross profit margin expanded 10 basis points (bps) from last year, to 35.1%. The impact of the enhanced gross margin trickled down, leading the operating income to soar 24.4% to $2,191 million during the quarter. Further, operating margin expanded 140 bps to 11.4% from approximately 10% in the year-ago quarter. Glimpse at Fiscal 2014 Taking a look at the yearly performance, Home Depot s adjusted earnings for fiscal 2014 came in at $4.58 per share, up 21.8% year over year, coming much ahead of the Zacks Consensus Estimate of $4.49. Including one-time items, earnings for the fiscal ascended 25.3% to $4.71 per share. Further, net sales for the fiscal escalated 5.5% year over year to $83,176 million. Net sales also cruised ahead of the Zacks Consensus Estimate of $82,956 million. Balance Sheet and Cash Flow Home Depot ended fiscal 2014 with cash and cash equivalents of $1,723 million, long-term debt (excluding current maturities) of $16,869 million and shareholders equity of $9,322 million. Also, during fiscal 2014, the company generated $8,242 million of net cash from operations. Fiscal 2015 Outlook Following a spectacular year, Home Depot hiked its quarterly dividend, announced its capital allocation plans and issued a favorable guidance for fiscal 2015. The company declared a 26% hike in its quarterly dividend to $0.59 a share, payable on Mar 26, 2015, to shareholders of record as on Mar 12. Also, management authorized a share buyback plan of roughly $18 billion, which it aims to complete by 2017 as one of its capital allocation goals. In fiscal 2015, the company plans to buy back shares worth roughly $4.5 billion. Further, it plans to spend $1.6 million as capital expenditure and expects to generate cash flow of roughly $9 billion from its business in the fiscal. Equity Research HD Page 2
With these announcements, the company reaffirmed its capital allocation objectives, including achieving a target dividend payout ratio of about 50%. Also, it aims to achieve a return on invested capital of 27% by fiscal 2015. Additionally, taking a cue from the strengthening U.S. dollar, the company projects sales growth of 3.5% 4.7% for fiscal 2015, with comps growth anticipated in the range of 3.3% 4.5%. Also, the company forecasts gross margin to remain flat year over year, while it projects operating margin to expand 60 bps in the fiscal. Tax rate in the fiscal is anticipated to be nearly 37%. Consequently, Home Depot envisions diluted earnings per share to grow in the range of 8.5% 10%, with earnings expected in the band of $5.11 $5.17 per share in fiscal 2015. This guidance includes the expected impact of share buybacks in fiscal 2015. VALUATION Currently, Home Depot s trailing 12-month earnings multiple is 25.4x compared with the 29.7x industry average and 18.5x for the S&P 500. Over the last five years, Home Depot s shares have traded in the range of 14.7x to 24.2x trailing 12-month earnings. The company is trading at a premium to the industry average based on forward earnings estimates. Our target price of $122.00, 23.5x 2015 EPS, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low The Home Depot, Inc. (HD) 22.4 19.4 14.8 19.3 25.4 24.2 14.7 Industry Average 22.1 17.5 16.5 18.2 29.7 N/A 21.2 S&P 500 16.8 15.7 10.7 15.3 18.5 19.4 12.0 Lowe's Companies Inc. (LOW) 22.8 19.4 15.7 20.2 29.6 27.3 12.6 Fastenal Company (FAST) 22.2 19.6 16.6 22.0 25.2 43.2 26.6 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA The Home Depot, Inc. (HD) 13.6 13.7 2.4 51.7 1.8 1.8 15.4 Industry Average 6.2 6.2 6.2 26.0 1.6 0.4 4.8 S&P 500 5.3 9.8 3.2 25.5 N/A 2.1 N/A Equity Research HD Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research HD Page 4
OVERVIEW Based on net sales, Home Depot Inc. is the world s largest home improvement specialty retailer with over 2,200 retail stores across the globe, offering a diverse range of branded and proprietary home improvement items, building materials, lawn and garden products, and related services. With the help of its stores, the company operates throughout the United States (including the territories of Puerto Rico and the Virgin Islands), Canada and Mexico and employs more than 300,000 associates. The company s average store area is almost 105,000 square feet with approximately 23,000 square feet of additional outside garden area. The company typically serves three primary customer groups: Do-It-Yourself (D-I- Y), Do-It-For-Me (D-I-F-M), and Professional Customers. D-I-Y Customers: These customers are usually home owners, who prefer purchasing products and completing installations on their own. D-I-F-M Customers: These customers are usually home owners, who purchase products on their own and employ third-parties to complete the projects and installations. Professional Customers: This customer segment mostly comprises professional remodelers, general contractors, repairmen, small business owners, and tradesmen. REASONS TO BUY Customer-Friendly Store Operations to Drive More Traffic: Home Depot is a leading player in the highly-fragmented home improvement industry. The company has been revamping itself by concentrating on square footage growth and maximization of productivity from its existing store base. In addition, the company has implemented significant changes in its store operations to make them simpler and more customer-friendly. We believe these initiatives will induce more traffic to its stores. Further, the company remains focused on developing merchandising tools and increasing investment in e-commerce to boost top-line growth and enhance market share. Strong Earnings Trend & Positive Outlook Show Future Potential: The world s largest home improvement retailer has been reporting strong financial statistics and growing since 2008 while showing steady improvement in revenue, EPS, and net income. In the third quarter of fiscal 2014, the company reported improvement in both top and bottom lines and reaffirmed its sales forecast for the fiscal year. The company has also slightly adjusted its earnings guidance to reflect the benefit of year-to-date share repurchases and costs related to the recent data breach. Home Depot has posted an average positive earnings surprise of 3.42% in the past year and is expected to report earnings of $0.82 per share for the quarter, ending in Jan 2015, representing 12.3% growth year over year. That being said, we believe Home Depot is well positioned to benefit from the gradually recovering housing market and expect it to continue with its upbeat performance going forward. Growth Catalyst: Home Depot has been implementing several initiatives to drive long-term growth. The company is trying to widen the range of its premium products, as this category has witnessed strong momentum over the last several quarters. This home improvement retailer is also looking for opportunities to open stores and enhance its e-commerce capabilities. Moreover, with the acquisition of window covering retailer Blinds.com, Home Depot has strengthened its presence in the rapidly growing online coverings market. We believe that these initiatives will drive the company s top and bottom-line growth in the long run. Equity Research HD Page 5
Disciplined Capital Strategy: Home Depot has always maintained a disciplined capital allocation strategy, focused on making investments to develop its business while using the excess cash to enhance shareholder returns through dividend payouts and share buybacks. Home Depot ended the third quarter with cash and cash equivalents of $2,181 million and generated $6,247 million of cash from operations. Year-to-date, the company deployed its available funds to buy back $5.6 billion worth shares, pay dividend of $1.9 billion, capital expenditures of nearly $1 billion and long-term debt repayment of $30. We believe that the company is on track to achieve its target of increasing its dividend payout to 50% from the current level of 41% and complete nearly $17 billion worth of share repurchases by the end of 2015. REASONS TO SELL Macroeconomic Headwinds: Heavy job losses and reduced access to credit have led to a sharp fall in consumer discretionary spending on big-ticket items. With the global economic environment still struggling to recover, we believe that spending on big remodeling projects will likely remain under pressure until the housing market stabilizes and consumer-spending fully rebounds. Stiff Competition May Strain Margins: In the home improvement retailing business, Home Depot faces stiff competition from Lowe s, Sherwin-Williams Company and other home supply retailers on attributes such as location, price and quality of merchandise, in-stock consistency, merchandise assortments, and customer service. This may weigh on the company s results. Risk of Operating in Overseas Market: Due to its exposure to the international market, Home Depot remains exposed to currency fluctuations. Weakening of foreign currencies against the U.S. dollar may require the company to either raise product prices or contract profit margins in locations outside the U.S. An increase in product price may have an adverse impact on consumer demand. Equity Research HD Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HD. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1136 companies covered: Outperform - 16.6%, Neutral - 76.7%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research HD Page 7