Home Depot Profits Bolstered by Elevated Spend

We plan to raise our $225 per share fair value estimate for wide-moat Home Depot HD by a high-single-digit rate, after incorporating better-than-expected sales and profit results from the company’s third-quarter print. In the period, Home Depot delivered 10% sales growth, supported by 6% same-store sales (30% two-year stack), which were well ahead of the 4% comp decline we had forecast. And although the gross margin was just 10 basis points ahead of our outlook, at 34.1% (down only around 5 basis points despite higher transportation costs and less favorable mix), the selling, general, and administrative ratio leveraged ahead of our 18% estimate, coming in at 16.8%, representing a 130-basis-point year-over-year decline. Operating expenses benefited from the roll off of COVID-19-related costs and fixed cost leverage. All in, this led to a 15.7% operating margin, a high-water mark for the third quarter, implying a shift away from spending on the home has failed to surface yet.

Even with a lift in our fair value, we view shares as rich, having increased nearly 50% year to date, significantly above broad market growth. While we surmise professional growth could persist the next few quarters, given the existing backlog of housing-related projects (and as evidenced by comp transactions over $1,000 growing 18%), we anticipate this will normalize over the longer term. As such, we don’t plan to alter our long-term outlook calling for 3%-4% same-store sales growth and 15% operating margins. In our opinion, Home Depot will continue to reinvest in its business to ensure its products and offerings maintain relevance with its DIY and professional consumer bases, bounding the growth of operating margin dollars, which should rise at a 4% average pace in 2022 and beyond. This should still allow Home Depot to generate leading retail ROIC results, which average around 35% over the next five years.

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