When Home Depot (HD) last reported earnings we noted that the company was performing extremely well, but investors were worried about the company’s ability to grow sales this year compared to the heavy spending on home upgrades during the peak of stay-at-home orders in 2020.  4Q20 also saw some pressure on margins from elevated expenses related to COVID.  Three months ago, these issues led the stock to react poorly to excellent earnings and provide an attractive buying opportunity in Northlake’s opinion.  The shares ultimately rebounded and reached new highs in early May, gaining almost 20% from the post-earnings low in February.

Earlier this week, HD reported 1Q21 results that easily exceeded expectations and answered some of the questions we addressed in our last blog post.  Sales soared around 30% and are now projected to rise in 2021 against the tough 2020 comparisons.  Margins bounced back thanks to the big sales gain providing leverage in operating expenses.  Gross margins did compress a little thanks mostly to soaring lumber prices and also to general stress on the supply chain.  Most importantly, unlike after the big earnings beat in the prior quarter, analyst estimates are moving up materially based on the 1Q21 results and management commentary about current and future trends. 

Management noted that sales strength in May matched March and April despite much tougher comparisons.  Investors now expect 2021 sales to grow in the mid-single-digit range vs. flat to slightly down expectations previously.  Northlake thinks new expectations may still prove conservative.  HD is well positioned with Pro customers that represent almost half of sales.  Many people are only now beginning to let contractors back in their homes, so strength in this area should sustain at least through 2021.  Northlake also believes that the pandemic has led to a secular shift in consumer preferences such that the balance between spending on experiences and things will shift modestly in favor of things over the next several years.  Homes are the most important “thing” for most people in the US.  Finally, it appears millennials are beginning to buy homes at a rate more consistent with prior generations.

Gross margins will continue to present a challenge as lumber and other commodity prices remain elevated and supply chains are still challenged especially in the ability to receive deliveries.  We noted in our last update that HD should begin to see leverage on operating expenses, especially as COVID-specific expenses begin to roll off.  1Q21 operating expenses far exceeded even our optimistic view and with higher sales ahead, this trend is sustainable.

As usual, management was still cautious about its financial outlook, falling back on the unprecedented impact of the COVID pandemic.  The company did not raise guidance although under questioning from analysts, management did seem to admit that the outlook was much improved.

The big run in HD shares from March through early May clearly had raised the expectation bar for 1Q21 and full year 2021 results.  The shares had pulled back ahead of the results due to investor positing and fell modestly after the report.  Northlake used this post-earnings pullback to add HD to the few accounts where it was not yet owned.

We are raising our target price from $308 to $375 based on a material upgrade to consensus earnings estimates that we still believe may prove low.  We had been assuming 22X estimated 2022 EPS of $14.  We now are using 25X 2022 estimated EPS of $15.  The think multiple expansion is warranted based on the company’s stronger growth profile and due to the fact that multiple for the market has risen over the past several months.

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