Home Depot: 3Q Recap (Good, but Not Good Enough for High Multiple)

What people wrote about:

Home Depot reported a great quarter that was better than consensus estimates.

What they're missing:

Home Depot 3Q results were actually below investor expectations. Trading at 22x 2014 EPS, small slip-ups will see stock corrections because of lofty expectations. With that said, the quarter was still solid from an executional standpoint.

The details:

There is a distinction between consensus estimates (an average of analyst estimates) and investor expectations (what most investors believe will occur, which may be generally set by the analyst yardstick but aren't necessarily aligned with it entirely). This quarter was a case where results were in-line with consensus (not above them), and below investor expectations. Home Depot reported EPS of $1.15, which was better than the consensus of $1.13. There were a couple one-time items that impacted that number, though. Specifically, Home Depot benefited from a $100 million pre-tax gain from the sale of HD Supply stock. If we exclude these charges (which we should because they won't be able to sell HD Supply stock every quarter), the company would have posted in-line results. Gross margin and SG&A were largely in line despite the increase in expenses associated with the data breach. Taken within the context of their recent history of EPS beats, guidance raises, and a 22x 2014 PE multiple, their results aren't bad by any means, but they didn't meet lofty expectations either.

The big picture:

With that said, it's important to keep the results in perspective. A 5% comp is still solid for a company of Home Depot's size, and they continue to gain share from their Lowe's. Monthly results were largely steady at roughly 5% each month, so there wasn't a gradual decline in the trend as the quarter progressed. The sell-side heavily defended Home Depot during the data breach, and it appears that they were right -- people didn't care about the security breach, and still flocked to stores. Furthermore, margin expansion continues as expected and Home Depot remains on track to hit their longer-term operating margin targets. More broadly, the home improvement industry still has a number of attractive characteristics (and I'll detail those in a post at some point in the future), and nothing has changed that. 

The end result is a company with a positive longer-term story in tact, but slight disappointments in the near-term that weighed on the stock today. While the story appears to be mostly positive, we have to remember that the stock prices a lot of those positives in at 22x 2014 EPS. This is ultimately the risk you take when you purchase stocks with high-flying multiples. 

A couple other tidbits:

  • The company mentioned that they were "impressed" with sales in November so far. We've obviously got a ways to go in the quarter, but it's encouraging to hear nonetheless.
  • The pro customer (a vital customer to Home Depot and an important gauge on the health of the housing market) continues to do better. Home Depot mentioned that their average ticket is now up to $6,600 from $6,000 a year ago. Large pro customers performed especially well and grew at twice the rate of Home Depot's average customer.
  • Online sales continue to grow rapidly with 40% growth in the quarter. Home Depot has done a great job of growing their online sales over the years, although they have also benefited from an industry that is somewhat more protected from online penetration than others (i.e. music, books, office supplies).