Home Depot (HD) reported strong 1Q20 earnings especially when compared to most other companies, including other retailers that were hurt badly by the economic shutdown.  HD stores were deemed essential and remained open, a huge advantage, but the big story in the quarter was digital sales up 79%, reaching 15% of sales.  Comparable store sales rose over 7% although profits were penalized by increased store level costs due to employee raises and bonuses and cleaning.  On the quarterly conference call, management noted sales trends had accelerated further in May with comparable store sales now up over 10%.  Nonetheless, due to volatile sales trends and uncertainty regarding elevated costs, guidance for 2020 was withdrawn.  Management emphasized that it was volatility in sales not concern about trends that led to withdrawing guidance.  This message was firmly reinforced when the company elected to continue to pay its dividend.

Northlake purchased HD in the first half of March when the economic shutdown first began.  To finance the purchase for clients, we sold holdings in MGM Resorts (MGM).  So far this trade has worked beautifully with HD up 23% and MGM up 4%.  Our thesis was to look for high quality, financially strong growth stocks that had fallen sharply but were likely in a position to emerge as a secular winner in world changed by the coronavirus experience.  HD fit the bill perfectly since the company had already emerged as a leader in ecommerce among store-based retailers and “nesting” at home seems likely to increase spending related to home improvement.  We overstayed our welcome in MGM but the company’s high balance sheet debt and COVID-19 risks surrounding live entertainment fit with our desire to reduce risk and upgrade quality in an unprecedented economic shutdown.

HD shares closed at an all-time high the night before 1Q20 earnings were released.  The positive quarterly report has been met by modest selling with the shares pulling back about -4%.  We believe the run up in the stock and all the talk about the nesting theme just set the bar too high for traders.  It is also fair to note that HD’s P-E multiple has expanded and now sits at a significant premium to its historical level.

Northlake believes HD’s position within the post-COVID nesting theme and enhanced ecommerce leadership justifies the premium valuation.  We believe HD shares can ultimately trade at 25 times next year’s consensus earnings of $11 for a target of $275, or 16% above current prices.  The pace of gains in HD will probably slow as the stock digests the move to all-time highs and investors possibly shift focus toward companies leveraged to reopening of the economy.  Northlake will happily remain patient with HD holdings and would look to add to positions on any meaningful weakness.

HD is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.