Stay-at-Home Spending Continues to Benefit Home Depot

Home improvement companies continue to take share of wallet, as evidenced by Home Depot’s HD robust third-quarter growth. Same-store sales rose 24.1% and revenue increased 23.2% to $33.5 billion in the quarter, ahead of our midteens forecast for both metrics. And an operating margin of 14.5% was 40 basis points better than we anticipated, as selling, general, and administrative costs were about 40 basis points lower than our forecast, coming in at 18.1%. However, SG&A costs are set to rise as Home Depot makes some of its temporary compensation programs permanent for front-line workers, leading to $1 billion in higher compensation annually. While this pressures operating margin performance, we ultimately think it benefits the durability of Home Depot’s wide moat, keeping the brand elevated by employing dedicated, long-term, knowledgeable workers.

We plan to raise our $200 fair value estimate by a mid-single-digit rate but still view shares as rich, trading at above 20 times our 2021 EPS estimate. Our intrinsic value change consists of five parts. First, third-quarter outperformance adds about $4, as expenses leveraged on higher sales. Then, continued fourth-quarter momentum (discounted for the lack of a 53rd week in 2020) elevates our fair value by $3, as we plan to raise our same-store sales forecast to a midteens rate. Third, the acquisition of HD Supply in 2021 adds $5 to our fair value, as the tie-up brings $3 billion in sales in its first year owned, with a similar operating margin (now that it has solely become a facilities management business, after pruning other segments). Next, the time value of money supports a $3 increase. Finally, higher SG&A spending pressures the fair value by around $6. This final factor has the largest impact on our change, as we see the elevated spending on employees occurring over the rest of our forecast. This will pressure our terminal operating margin to just over 15% from 16% prior.

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