Home Depot (HD): 2019 Top Picks' Mid-Year Update

07/11/2019 5:00 am EST

Focus: CONSUMER

Chris Graja

Senior Analyst: Retail, Argus Research Corporation

Chris Graja, an analyst for Argus Research, chose Home Depot (HD) as his favorite investment idea for 2019. The stock has since risen 22%. Here's his latest update on the home and building products retailer.

In May, Home Depot (HD) reported fiscal 1Q20 EPS of $2.27, up 9.1% from the prior year, reflecting a 6.4% increase in operating income and continuing share repurchases. The stock rose 20% in the first half of 2019.

Increasing returns on capital, signs of improving customer service during recent store visits, a solid economic environment, and impressive execution of the business plan support our conviction that even after raising the operating margin by more than 400 basis points over the last five years, Home Depot still has room to increase earnings.

In the first quarter of fiscal 2020, the trailing four-quarter return on invested capital was 45.4%, up 940 basis points from last year's first quarter.

Based on Home Depot's sales forecasting, which has correctly anticipated growth in the home improvement market, the most important drivers of future sales are likely to be based on the overall economy rather than housing activity.

HD is focusing on strong GDP growth, housing turnover, household formation, homeowners' equity and the age of the average home. Some homeowners may stay put as a result of higher mortgage rates and use their improved finances to make improvements to their existing home.

We continue to believe that there has been significant underinvestment in housing. About 70% of U.S. homes are more than 25 years old and likely in need of upgrades and repairs. Private Fixed Residential Investment is still near a 66-year low, at 3.2% of GDP, and well below the average of 4.6% since 1946.

Fixed residential investment has been a drag on economic growth in the last three quarters. We would expect PFRI to approach and likely exceed the long-term average before we'd be concerned that too much capital has been allocated to residential housing.

We think the shares are attractive at a small premium to the S&P 500. The company’s multiple reflects investors’ perception of HD as a high-quality business, with a leading market position and additional upside from economic growth. We are maintaining our buy rating with a price target of $220.

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