Home Depot shares are up about 50% since Northlake purchased them for clients in March.  This is far beyond what we expected at the time.  This also explains why the stock has sold off about -4% since reporting fantastic 2Q20 earnings.  We have often discussed how in the short term stocks trade based on expectations.  We have also noted that stocks trade based on the future rather than the past or current situation.  For HD, expectations were elevated above even the consensus estimates and the stock had run up in the last month especially anticipating the exceptional results.  None of this really matters in the long term where Northlake concentrates its stock selection.  On that basis, we still see modest upside potential for HD shares. 

The highlight of 2Q20 results was comparable store sales growth of 23%.  This level of growth has continued through mid-August.  Given overall retail sales growth in the low to mid-single digits this is an extraordinary result.  Households have clearly reallocated spending toward the home rather than retrenched during the pandemic induced recession.  Vacations, out of home entertainment, and apparel are out of favor, and fixing up your home is in.  EPS came in at $4.02, +27% vs a year ago and ahead of the $3.70 consensus. 

If there was a blemish on the report, it was that margins did not expand despite the sales growth.  Normally, when retailers exceed expectations on sales, there is margin expansion as SG&A had been budgeted at the lower expected level of sales.  However, HD spent heavily on employee benefits/bonuses and COVID mitigation.  Some investors find this disappointing and believe the higher spending will have to be sustained even as sales fall back to more normal growth rates.  A more bullish view to which Northlake subscribes is that the company is executing extremely well against the unprecedented surge in demand by holding profitability against hard to predict and unusual expenses.

Northlake believes that the shift in consumer spending patterns is likely to hold well into 2021 if not longer.  EPS in 2021 could approach $12 (current consensus is $11.35).  A P-E of 25X provides upside to $300 above our prior target of $275.  Additional upside could come from P-E expansion relative to the market but we are less willing to count on this factor given P-E’s everywhere are elevated due to historically low risk-free interest rates.  Upside of 7% is not particularly exciting but with uncertainty remaining about the path of the virus, the upcoming election, tensions with China, and future stimulus, we are comfortable sticking with high quality stocks like HD that have the wind at the back of business fundamentals. 

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.