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The Home Depot, Inc. (HD) Bringing New Life to Old Wood? Earnings Analysis

The Home Depot, Inc. (NYSE:HD) discussed its Q2 2013 earnings yesterday. Craig Menear – Executive Vice President, highlighted The Home Depot, Inc. (NYSE:HD)’s focus for the third quarter: innovation. This includes Behr Premium DeckOver wood and concrete coatings, the introduction of an LED 90-watt equivalent floodlight from Cree (see our recent analysis on Cree, Inc. Will Cree light the way in LED), and an adhesive foam gel with eight times more coverage than traditional adhesives for Pro customers. Our analysis (read post) suggests that the market might have some questions about the company’s long-term strategy and also that The Home Depot, Inc. (NYSE:HD) might be under-investing in growth.

The Home Depot, Inc. (NYSE:HD)

Are Home Depot’s annual revenues coming at the expense of earnings?

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Based on the preliminary financial results for the quarter ended 2013-07-31 we analyze The Home Depot, Inc. (NYSE:HD) relative to its peers (scroll to the end of the post for the peer list used). The table below shows the preliminary results along with the recent trend for revenues, net income and returns.

Quarterly (USD million) 2013-07-31 2013-04-30 2013-01-31 2012-10-31 2012-07-31
Revenues 22,522.0 19,124.0 18,246.0 18,130.0 20,570.0
Revenue Growth % 17.8 4.8 0.6 (11.9) 15.5
Net Income 1,795.0 1,226.0 1,021.0 947.0 1,532.0
Net Income Growth % 46.4 20.1 7.8 (38.2) 48.0
Net Margin % 8.0 6.4 5.6 5.2 7.4
ROE % (Annualized) 45.1 28.7 23.0 21.4 34.4
ROA % (Annualized) 16.6 11.3 9.7 9.1 14.4

Valuation Drivers

The Home Depot, Inc. (NYSE:HD)’s current Price/Book of 7.0 is about median in its peer group. HD’s operating performance is higher than the median of its chosen peers (ROE of 30.1% compared to the peer median ROE of 14.4%) but the market does not seem to expect higher growth relative to peers (PE of 22.0 compared to peer median of 23.7) but simply to maintain its relatively high rates of return.

The company’s asset efficiency (asset turns of 1.9x) and net profit margins of 6.4% are both median for its peer group. HD’s net margin is its highest relative to the last five years and compares to a low of 3.2% in 2009.

Questions on Long-term Strategy?

While The Home Depot, Inc. (NYSE:HD)’s revenues have grown faster than the peer median (4.1% vs. 2.3% respectively for the past three years), the market gives the stock an about peer median PE ratio of 22.0. This suggests that the market has some questions about the company’s long-term strategy.

Is Home Depot Under-Investing in Growth?

HD’s annualized rate of change in capital of -0.6% over the past three years is around the same as its peer median of -0.6%. This investment has generated a better than peer median return on capital of 13.7% averaged over the same three years. The greater than peer median rate of return suggest that the company may be under investing in growth.

Earnings Quality

Home Depot’s net income margin for the last twelve months is around the peer median (6.4% vs. peer median of 5.3%). This average margin and relatively conservative accrual policy (3.1% vs. peer median of 1.5%) suggests possible understatement of its reported net income.

The company’s accruals over the last twelve months are positive suggesting a buildup of reserves. In addition, the level of accrual is greater than the peer median — which suggests a relatively strong buildup in reserves compared to its peers.

Trend Charts

Quarterly Net Margin Trend for Home Depot (NYSE:HD)Annual Net Margin Trend for Home Depot (NYSE:HD)Quarterly Accruals Trend for Home Depot (NYSE:HD)Annual Accruals Trend for Home Depot (NYSE:HD)

Peers used for Home Depot analysis

We used the following peer-set: Lowe’s Companies, Inc. (NYSE:LOW), Kingfisher plc (ADR) (OTCMKTS:KGFHY), Lumber Liquidators Holdings Inc (NYSE:LL) and Sears Holdings Corporation (NASDAQ:SHLD).

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