Home Depot (HD) shares are unchanged since August including a pullback of about 5% since reporting 3Q21 earnings in November.  Not much has really changed over this time frame.  The stock is just consolidating the huge move off the March COVID-driven low.  With the shares up from Northlake’s initial purchase at $190 to almost $300 prior to the recent pullback, expectations have moved higher.  This led to the shares pulling back despite reporting 23% comp store sales growth and 26% EPS growth in 3Q21.  Despite each of these metrics exceeding expectations, investors chose to focus on flat operating profit margins.  Comparable store sales growth over 20% should lead to higher margins but pandemic related expense increases in labor, supply chain, and sanitation held back margins.  With the stock’s valuation having expanded significantly, a single disappointing metric led to the shares correcting.

Northlake chose to take advantage of the pullback and add to positions in Home Depot that were established in March.  We believe that the focus on the home will outlive the pandemic, supporting a higher level of sales growth over the next few years.  The company should be able to manage the higher cost structure with modest savings on the elevated expenses as the pandemic subsides.

We also look favorably on the HD’s announcement that it would be acquiring HD Supply Holdings, a leader in the MRO distribution business.  Home Depot sold HDS to private equity as the company wanted to focus on its core retail business.  Over the last few years, HD has had great success expanding its total addressable market by focusing more on serving Pro customers like contractors.  Re-entering the maintenance, repair, and operations segment build son the Pro focus and further expands the company’s long-term opportunity.  The acquisition provides small EPS accretion and leaves HD with plenty of cash to fuel dividends and share repurchases.

We view HD as a core holding for Northlake clients.  HD has the blue chip characteristics of above GDP growth, financial strength, and strong senior management that we seek in most of our individual equity investments.  We see upside to over $300 in over the next three to six months driven by sustained comparable sales growth and an easing of operating margin pressures.  At $300, the shares would be valued at 16 times 2021 estimated EBITDA, a modest and well-deserved premium to the S&P 500.  On forward 12-month EPS of $12.30, the shares would be valued $307.

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