Home Depot (HD) reported excellent 3Q21 results with sales continuing to grow ahead of consensus expectations and surprisingly good gross and operating margins despite supply chain driven cost pressures. Northlake’s investment thesis on HD has been built around three ideas. First, we believe that the pandemic has created a secular increase in willingness of consumers to spend money on their homes. Second, management is best in class and executes on a day-to-day and strategic basis. Third, increased investment in ecommerce and Pro capabilities extend HD’s competitive moat.  3Q21 results support our investment thesis fully.

Stock Reaction: HD shares have soared nearly 7% since reporting results building on a strong run since the initial sell-off after reporting the prior quarter. The shares sit at all-time highs although valuation remains within historical bounds.  Investors in retail stocks have been very sensitive to trends in profit margins this quarter and HD easily satisfied concerns.

Earnings Analysis: Sales, operating income, and EPS all exceeded Wall Street consensus estimates. Strength was especially notable in big ticket items like appliances and power tools. Traffic remains down about 5%, but average ticket was up 12%. Management noted that HD’s labor expenses are most sensitive to traffic (staffing the store when it is crowded), so the combo of light traffic and large tickets contributed to the margin flow through. Gross margins were down just 5 basis points, a great performance compared to other retailers. Supply chain issues are easing a little but still remain.

Looking ahead, management spoke optimistically about a larger total addressable market consistent with Northlake’s view on the secular change in home-focused spending. On a near-term basis, the sharp rise in housing prices is providing further support to demand. Also helping 2022 is HD’s recent focus on the Pro customer. Much of the pandemic demand has been for DIY. Pro demand has a reopening aspect as many consumers are still just beginning to be comfortable with letting workers in their home. On margins, management seems confident they can continue to manage the supply chain issues.  In addition, a material portion of the excess costs related to COVID are beginning to fall away for a net benefit even after increasing employee pay.

Target Price: HD has exceeded our prior target price of $375. We still see upside as the company’s excellent performance in 3Q21 supports a higher P-E multiple. higher estimates, and willingness to base our target on 2023 earnings. Last quarter, we noted our $375 target was based on 25X 2022 estimates or 23X 2023. We now think the shares can support 25X our increased 2023 estimate of $17 for a target of $425. We would note that this is not big upside from current trading levels, but as with other blue chip growth stocks like Apple, we are comfortable holding shares and letting value build through continued earnings and cash flow growth and the passage of time.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