The Recovery Rally in Home Depot Stock Has Legs

Stocks to buy

It’s been a tough stretch for shares of home improvement retailer Home Depot (NYSE:HD). In early September 2018, Home Depot stock was touching all-time highs around $215 and everything was going right for the company. Then, the U.S. economy started to cool, the Fed kept hiking interest rates and trade relations between the U.S. and China got worse.

This created a triple headwind for Home Depot stock. By Christmas Eve, Home Depot stock had dropped 25% to below $160.

That was a dip worth buying. Since Christmas Eve, Home Depot stock has rallied nearly 15% to almost $180 as the macroeconomic outlook has improved. Namely, a strong December jobs report put to rest recession fears, the Fed has backed off its “must hike rates at all costs” mantra and there’s optimism regarding how trade talks between the U.S. and China will play out in the new year.

This recovery rally in Home Depot stock could still be in its early innings. At its core, so long as U.S. economic fundamentals remain healthy, the U.S. housing market will remain healthy too. As long as that’s true, Home Depot will continue to report solid revenue and profit growth — and Home Depot stock will rise.

More than that, Home Depot continues to innovate in order to grow the company’s addressable market. Most recently, this expansion includes a dive into premium home remodeling through a beta Design Center in San Diego. At scale, these Design Centers could constitute a huge growth opportunity for Home Depot.

All in all, Home Depot stock looks good here. The growth trajectory remains healthy, innovation continues to drive addressable market expansion and the valuation is reasonable. As a result, this bounce back in Home Depot stock should persist for the foreseeable future.

The Economy Remains Healthy

As goes the economy, so goes the housing sector and so goes Home Depot stock. That is simply the nature of being America’s largest home improvement retailer.

In late 2018, there were concerns regarding a rapid slowdown in the U.S. economy which, coupled with a hawkish Fed, had the potential to spark a recession in 2019 or 2020. Home Depot stock dropped sharply on these fears. After all, in a recession, no one is spending on home improvements. Home Depot’s revenues drop. Profits dry up. The stock falls. (See 2008-09, when the stock lost more than half of its value.)

But such fears seem premature, at worst, and overstated at best. The December jobs report was a blowout one. The U.S. economy added more than 300,000 jobs in the last month of 2018, while wages rose in excess of 3%. The unemployment rate remained below 4% and the participation rate rose to its highest level in recent memory. Housing starts remain on a long term uptrend, while permits rose to a 7-month high in November. Consumer confidence remains robust and so does business confidence.

Overall, the economy is still growing at a healthy rate. Granted, it’s not the red-hot growth that we saw in 2017-18, and rising rates will continue to provide a headwind to the housing market, but, in the big picture, the economy is still doing just fine. A “just fine” economy is good enough for Home Depot to continue to report solid revenue and profit growth.

Design Center Innovation Drives TAM Expansion

An exciting element of Home Depot stock is that management continues to innovate. Such innovation drives addressable market expansion, grows the company’s revenue potential and elongates the growth runway.

A recent example of this innovation is the company’s plunge into the high-end home remodeling market. Home Depot had a presence in this market in the 1990’s and early 2000’s through Expo Design Centers, which were essentially home remodeling showrooms and services that catered to an upper-income demographic. These design centers were a sharp departure from Home Depot’s traditional warehouse style, and they worked well enough… until 2008. That’s when the housing market crashed and Home Depot was forced to shutter its Expo unit.

Now, Home Depot is jumping back in.

In late 2017, Home Depot acquired high-end linen e-retailer The Company Store. A few months later, in mid-2018, Home Depot sent out an e-mail to customers, which stated the following: “Your favorite home improvement retailer is about to become your new favorite décor destination.” Around the same time, Home Depot launched its first Home Depot Design Center in San Diego, and it essentially looks like an upgraded version of the Expo Design Centers from the early 2000’s.

Broadly speaking, over the past twelve months, Home Depot has laid the groundwork to bring back the Expo business from the dead, and re-enter what has become a very large high-end home remodeling market.

Depending on who you ask, the home remodeling market is anywhere from a $100 billion market in the U.S. to a several-hundred-billion-dollar market globally. But the specifics here aren’t important. The important thing is that, through innovation, Home Depot is jumping into new markets, expanding its addressable revenue pool, growing the company’s long-term profit potential and elongating its growth narrative. These are all positive things that will contribute to Home Depot stock heading higher in the long run.

Bottom Line on HD Stock

Home Depot stock is a long term winner with a favorable near- to medium-term growth outlook, thanks to continued strength in the U.S. economy.

At 24 times forward earnings (versus a five-year average forward multiple of 25), the valuation is sensible and arguably discounted. As such, this stock’s recovery rally has legs, and won’t stall out at $180.

As of this writing, Luke Lango was long HD. 

Products You May Like

Leave a Reply

Your email address will not be published. Required fields are marked *