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  • Glenn

Home Depot: A building block for the portfolio.

Opdateret: 8. maj

Home Depot is the largest global home improvement retail company. Management is determined to invest in strengthening Home Depot's position with its customers, leveraging its scale and low-cost position to drive growth faster than the market, and deliver shareholder value. If management succeeds, Home Depot could continue to be a long-term compounder for investors. The question is: At what price are the stocks considered attractive? This is what I am going to investigate in this analysis.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.

For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Home Depot. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Home Depot's direct competitors either. Thus, I have no personal stake in Home Depot. If you want to purchase shares or fractional shares of Home Depot, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.

Home Depot was founded in Georgia, USA, in 1948 and has since grown to become the world's largest home improvement retailer based on net sales. Home Depot sells a wide assortment of building materials, home improvement products, lawn and garden items, decor products, and maintenance, repair, and operations products, totaling approximately 30.000–40.000 different items. They also offer services such as home improvement installations and tool and equipment rentals. Home Depot has 2.335 stores located throughout the United States (including Puerto Rico, the U.S. Virgin Islands, and Guam), Canada, and Mexico. Home Depot serves two customer groups: do-it-yourself (DIY) customers and professional customers. Their customers purchase their products both online and in physical stores. In fact, 60% of their sales come from customers who shop with them through both channels. This success has made Home Depot the fifth-largest e-commerce player in North America across all segments of retail. Home Depot has a clear strategy of providing the best customer experience, maintaining its position as a low-cost provider, and being the most efficient investor of capital in its sector. Home Depot has a significant brand moat as it is one of the most iconic and valuable brands in the world.

The CEO is Ted Decker. He joined Home Depot in 2000 and held various positions within the company before assuming the role of CEO in 2022. Prior to joining Home Depot, he held various positions in companies such as Kimberly-Clark Corp, Scott Paper Co., and PNC Bank. He holds a bachelor's degree in English from The College of William and Mary and a master's degree in Business Administration from Carnegie Mellon University. Throughout his more than twenty years and in various roles at Home Depot, Ted Decker has developed a deep knowledge of all areas of the business. He has been credited with creating a seamless, interconnected shopping experience for professional and do-it-yourself (DIY) customers. He integrated the online and in-store realms to provide better service to customers. Ted Decker has only been the CEO during the challenging years of 2022 and 2023, so it is impossible to judge him based on his results. However, he does have vast experience in the company and a clear strategy on how Home Depot will grow moving forward. Furthermore, according to Comparably, he has an employee rating of 74/100, placing him in the top 25% of similar-sized companies, which is also commendable. Hence, although he has only been CEO for a short time, there may be some uncertainties regarding his management abilities. However, I still have confidence that he has the necessary experience to lead Home Depot in the future.

I believe that Home Depot has a strong brand moat. However, I believe that there are some uncertainties regarding the management. Now let us investigate the numbers to see if Home Depot lives up to our requirements for a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. These numbers are certainly encouraging, as Home Depot has consistently delivered a return on invested capital (ROIC) well above 10% every year for the past ten years. In fact, ROUC has been above 20% every year in the past ten years, which is very impressive. Even more impressive is that Return on Invested Capital (ROIC) has been above 30% since 2018. ROIC decreased slightly in fiscal year 2024 (from February 1, 2023, to January 31, 2024), which has been a challenging period for most companies due to macroeconomic factors. Nonetheless, I find these numbers impressive, and any investor should be delighted to see such figures.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The initial thought regarding these numbers is that they are underwhelming. Equity has decreased almost every year in the past decade. The reason for this is that Home Depot, like many other companies, has taken advantage of low interest rates and has used debt to buy back shares. It is unlikely that this trend will continue, as interest rates have risen. This is the reason we have observed an increase in equity in fiscal years 2023 and 2024.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Home Depot has consistently increased its free cash flow every year until fiscal year 2023, which marked the first decline in free cash flow. However, fiscal year 2023 was challenging for most companies, including Home Depot. It is encouraging that free cash flow not only increased in fiscal 2024, but Home Depot also delivered its highest free cash flow ever in that year. Levered free cash flow margin has been relatively stable over the past decade. It is encouraging to note that Home Depot achieved its second-highest levered free cash flow margin in fiscal year 2024, following a challenging fiscal year in 2023. Free cash flow yield is also at its second-highest level in the past decade, which indicates that the shares are trading at a good value. However, we will revisit this later in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Upon calculating, I found that Home Depot has 2,82 years of earnings in debt. It is below the 3-year requirement. It is particularly encouraging that Home Depot has historically used debt to repurchase shares. Therefore, debt is not a concern when investing in Home Depot.

Based on my findings so far, I believe that Home Depot is an interesting company. However, no investment is without risk, and Home Depot also has its share of risks. One risk is competition. For most retailers, competition poses a risk, and Home Depot is no exception. Home Depot operates in a highly competitive, fragmented, and ever-changing industry. Thus, they face competition from a variety of retailers, suppliers, service providers, distributors, and manufacturers. These competitors range from traditional brick-and-mortar retailers to multichannel and online-only retailers. Furthermore, customers are increasingly shopping online and seeking faster and guaranteed delivery times, low-price or free shipping, or convenient pickup options. If Home Depot fails to offer competitive delivery and pickup options, it could negatively impact the company's profit margins and the demand for their products. Another risk is macroeconomics. Management has mentioned that in 2023, there were four increases in the Fed funds rate, a sharp decline in existing home sales, and approximately 110 basis points of competitive pressure from lumber deflation. However, they still expect pressures on our business in fiscal 2024. Personal consumption growth, as measured by personal consumption expenditures, is expected to decelerate compared to 2023. The industry share of personal consumption expenditures also remains slightly elevated relative to 2019 and has been gradually approaching 2019 levels. Furthermore, management has mentioned that higher interest rates will likely continue to pressure demand for larger projects. They also noted a continuation of the trend observed throughout the year, with softness in certain big-ticket discretionary purchases. Labor needs and labor costs. One of Home Depot's strategic focuses is customer service, as they aim to provide the best customer experience in home improvement and develop differentiated capabilities for their customers. One way to deliver the best customer service is by ensuring an adequate number of employees. Previously (from 2007 to 2013), Home Depot tried to decrease the number of employees per store, but sales per store decreased significantly. Since then, Home Depot has changed its strategy to have more employees per store. Therefore, Home Depot needs to attract, develop, and retain a large number of highly qualified employees. Currently, Home Depot employs approximately 475.000 people, and since 2021, we have seen a significant increase in wage growth. If this wage inflation continues, it will be difficult for Home Depot to control costs while maintaining the high level of customer service that is one of their strategic pillars. Furthermore, the unemployment rate remains low, which could pose challenges in attracting new skilled employees.

There are also plenty of reasons to invest in Home Depot. One reason is the opening of new stores. Home Depot sees new stores as an opportunity to boost sales. Thus, Home Depot plans to open approximately 80 new stores over the next five years. Their current network of 2.335 stores throughout North America makes Home Depot the most convenient physical destination for customers to shop for their home improvement products. Home Depot has a prime real estate footprint that offers convenience for customers, which management believes is extremely difficult to duplicate. Home Depot will continue to expand its presence strategically by investing in new stores in regions that have seen substantial population growth or where it is necessary to alleviate pressure on existing high-traffic stores. Management has mentioned that they are already seeing great results for many of the 13 new stores they opened in fiscal 2024. An attractive customer base. Home Depot believes that its customer base is one of the most attractive in any sector of the economy. Home Depot's customer base has higher-than-average incomes, and 80% of their customers own their homes, which compares to a home ownership rate of 66% across the United States. And their home, which is the most valuable asset for most of their customer base, has appreciated by 40% since 2019. While we may observe weaker short-term price appreciation in housing, the long-term price appreciation is expected to increase over time. Once this happens, it will drive demand for home improvement. Furthermore, homes continue to age, with 50% of the housing stock being more than 40 years old. This indicates a greater need for home improvement, and management has referred to home improvement as a significant opportunity for Home Depot. Shareholder-friendly. Home Depot has an objective of creating shareholder value through its disciplined approach to capital allocation. Their capital allocation principles are as follows: First, they intend to reinvest in their business to drive growth faster than the market. Secondly, after meeting the needs of the business, they aim to pay a quarterly dividend. Third, after reinvesting in their business and paying dividends, Home Depot plans to return excess cash to its shareholders through share repurchases. It seems like a good strategy as Home Depot grows faster than the market and delivers a high return on invested capital (ROIC). The ten-year compounded annual growth rate on dividends has been 17,91%. And Home Depot has decreased shares outstanding by 24,73% in the past decade.

Now it is time to calculate the share price of Home Depot. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 15,11, which is from the fiscal year 2024. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 8,9% in the next five years, but I'm slightly more conservative. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Home Depot's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $129,02. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Home Depot at a price of $64,51 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 21.172, and capital expenditures were 3.226. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 2.258 in our calculations. The tax provision was 4.781. We have 992 outstanding shares. Hence, the calculation will be as follows: (21.172 – 2.258 + 4.781) / 992 x 10 = $238,86 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Home Depot's free cash flow per share at $18,03 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $207,12.

Home Depot is a great company that has delivered significant value for shareholders over the past decade. The company has a strong competitive advantage and a clear strategy for future growth. There are some uncertainties regarding management, as the CEO has only been in the position for a few years. However, he does have vast experience in the company, which means he has the skills to propel Home Depot forward. Home Depot operates in a highly competitive market, indicating that competition will always pose a long-term risk. However, Home Depot has been able to deal with competition throughout its history, and there is nothing to suggest that this will change. Macroeconomic factors will affect Home Depot in the short to medium term. Large projects have been postponed due to the high interest rates, and macroeconomics has also resulted in a decrease in certain big-ticket discretionary purchases. Furthermore, the industry share of personal consumption expenditures also remains slightly elevated relative to 2019, which could continue to decline and affect the industry in which Home Depot operates. Home Depot relies on its employees to provide the best customer service, and higher wages will impact Home Depot's bottom line. Nonetheless, Home Depot wants to continue opening new stores to increase sales. The company believes that its real estate footprint provides convenience for customers, which management considers nearly impossible for its competitors to replicate. Home Depot has an attractive customer base, and housing trends are expected to lead to increased spending on Home Depot products by this customer base. Finally, Home Depot is shareholder-friendly as it returns value to shareholders through growth, dividends, and reducing the number of shares outstanding. I believe that Home Depot is a great company, and I will buy shares at the Ten Cap price of $238. I might even consider purchasing a small position at a higher price.

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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

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