Home Depot reported better than expected EPS, sales, and comp store sales, but had a small margin shortfall.  The stock has reacted poorly to the results, but we remain bullish on the outlook.  HD shares are unchanged since last summer even as quarterly earnings have consistently grown at 20%.  This has led to a material compression in the stock’s P-E multiple on an absolute and relative basis.  The current P-E is below the market multiple for the first time since 2007.  We believe HD shares are a bargain at current prices given the company’s multiyear growth and financial profile.  Near -term trends are tricky as the company must lap the pandemic-driven 2020 boom in sales.  Northlake is willing to wait, if necessary.

We usually do not like to quote others but Credit Suisse analyst, Seth Sigman, captured the HD stock well by noting:

“Home Depot’s stock is caught in the usual cyclical dilemma; it outperformed early in this cycle, and now must compete with the prospects of a recovery in other parts of the economy, while battling difficult comparisons and the debate about what normalization in consumer spending actually means. Further, numbers are not moving up after today’s results, and margins in Q4 were messy.”

This explains the stocks sideways movement the last six months as well the reaction to a good 4Q20 earnings report.  It will take another quarter or two to resolve the issue of difficult comparisons.  Northlake believes current sales momentum will hold and allow HD to report positive sales growth in 2021.  Housing should remain strong post-pandemic as household formation improves among millennials and some levels of outmigration from cities is maintained.

HD management has always done a good job managing operations and finances.  The company has invested heavily in its supply chain over the past several years to enable leadership in ecommerce and serving professional contractors.  COVID costs have added another layer of spending.  We believe that the investments in secular initiatives should begin to pay off as the Pro business comes back and ecommerce and buy online/pick up in store continues to gain share of overall sales.  HD should begin to see leverage on these expenses, especially as a portion of the COVID expenses roll off.  This operating leverage should offset pressure on gross margins.  As 2021, moves along, HD should reveal that overall margins can be stable and then tick higher as sales growth returns to normal in the mid-single digits in 2022 and beyond.

Management did not specifically endorse this outlook but we believe they hinted at it.  Most likely, the unusual impact of the pandemic that boomed sales and increased expenses leaves the company wanting to maintain wiggle room in their outlook.  The reality is that no one knows for sure how the post-pandemic will play out.  We think management offered a very strong signal of confidence by raising the dividend 10% and restarting the stock buyback program.

We expect HD to prove the bears wrong and emerge through 2021 with positive sales growth and stable to improving margins.  The stock trades at less than 20 times 2022 earnings estimates, which is around a market multiple if S&P 500 earnings rebound as strongly as currently expected.  Should HD follow the path we expect, the stock should regain a premium to the market.  At 22X 2022 earnings HD shares would trade at $308, up 18% from current price levels, an excellent return for blue chip quality like HD.

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