Home Depot (HD) reported solid 2Q21 results with same store sales growing in-line with expectations and earnings ahead of consensus estimates. HD chose not to provide guidance given uncertainty related to the ongoing pandemic. Management had a positive tone on the outlook for 2H21 and the long-term housing environment. HD noted that August has started out at a similar pace to 2Q21, implying growth will continue this coming quarter. Northlake believes that the fundamental elements for success remain in place for HD: strong housing demand with limited supply, consumers shifting spending from experiences to things such as home improvement, significant exposure to professional contractors with large and growing project backlogs, and reliable, consistent execution from management.  

Stock Reaction:

HD shares fell 4.3% following 2Q21 earnings, likely due to elevated expectations since 1Q21 results alleviated investor fears about tough comparisons to strong 2020 growth. Last March, investors feared HD would not be able to grow in 2021 and 2022 due to tough comparisons driven by the heavy investments people made in their homes during the pandemic. Through the first half of the year, HD has proven that it can continue to grow, perhaps signaling strong repeat spending by newer customers. Overall, after 2Q21, analysts and investors should have more confidence in HD’s ability to grow earnings this year and next.

Earnings Analysis:

HD grew same store sales 4.5% even while lapping the incredible growth from 2020. This compares favorably to fears that sales would decline this year that were held as recently as last quarter. The rapidly falling cost of lumber since May along with inflated transportation costs negatively impacted gross margins more than expected, but HD was still able to beat earnings expectations thanks to leverage in operating expenses. The negative surprise on gross margins is expected to be contained to 2Q21 since the price of lumber should stabilize instead of continuing to rapidly fall. Transportation costs will remain elevated given ongoing supply chain struggles, as heavy pent-up demand has outpaced the ability to ramp up supply in most industries. HD is trying to offset high transportation costs with creative solutions such as exclusive use of their own ocean vessels for shipping containers. As long as sales continue to grow, volatile gross margins are a manageable headwind that should not prevent HD from achieving earnings growth for the next few years. HD will also benefit as certain costs related to the pandemic are no longer necessary, which could lead to higher operating margins and earnings.

Target Price:

Northlake is sticking with a $375 target based on 25X 2021 EPS or 23X 2022 EPS. HD has a long runway to keep growing from an enlarged base thanks to the pandemic-driven boost in 2020. The underpinnings for success are in place, but we are watching for signs of weakness in the housing market, changing consumer spending habits, or a slowdown in HD’s ability to keep efficiently expanding their store footprint that could undermine the long-term thesis.

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