Home Depot trades at bargain prices

The home-improvement retailer might be a smart buy while the economy begins to recover. The company reports earnings Tuesday.

By TheStreet Staff Nov 16, 2009 10:34AM

TheStreet.comHome financing © CorbisBy David MacDougall, TheStreet.com


Home Depot (HD) is thought to be intimately connected to the housing market. While that may be true, the actual impact may not be as acute as investors think. Home Depot stock might be a bargain while the economy is still in the early stages of a recovery -- and pop when improvement becomes more definite.


Home Depot will report third-quarter earnings Tuesday, and analysts are expecting a profit of 36 cents per share, down about 20% from the previous year's quarter. However, analysts have been consistently underestimating the company, which has beaten estimates by as much as 26% this year.


Analysts could be overly pessimistic on the company's prospects, or the company could be tempering expectations. Regardless of the reason, beating earnings estimates has helped the stock rise 30% in the past year, while the S&P 500 increased 17%. Shares of rival Lowe's have advanced 11%.


Bing: More on Home Depot


Rival Lowe's said third-quarter profit fell 30% to $344 million, or 23 cents a share. Excluding costs related to store closures and a tax benefit, Lowe's earned 24 cents, meeting analysts' estimates. Company executives said they're starting to see improvement in some of the hardest-hit markets, including in California, Florida and parts of the Southwest.


Weak activity in new-home construction has affected Home Depot, whose sales slid 8% last year and are on pace for a similar drop this year. But considering that the real-estate market has completely collapsed in many parts of the country, these declines should be bigger. That suggests that home improvement has helped offset lost new-construction business.


As people "turn their doing dials up a notch" to avoid the costs of professional help, as the company's commercials say, they're turning to Home Depot for supplies. A few toggle bolts aren't going to make a difference, but paint sales may do the trick. The chain might have also gotten a boost after stimulus money was made available for people who purchase energy efficient appliances.


Revenue has softened recently, but the company's return on equity has remained in double digits as increased leverage in recent years has allowed the company to support its operations without relying on its equity. Despite ramping up its leverage, the company isn't taking on unacceptable risk. Earlier in this decade, Home Depot's debt-to-equity ratio ranged from 0.15 to 0.25, which is very low. Additional debt has lifted the ratio to 0.6, which shouldn't cause investors concern.


Other retailers have fared a bit better during the recession. Wal-Mart and Target have added sales, while Best Buy and Bed Bath & Beyond are treading water. But Home Depot is no less attractive and could even be undervalued considering the negativity that any stock connected to the housing industry has endured during the past year. Home Depot shares have a price-to-earnings ratio of 16, making it cheaper than the retail industry average of 25.


Expectations are low for tomorrow's earnings release. With new housing data scheduled for Wednesday, Home Depot could see a lot of movement this week. Trading could be very profitable in the short term, but long-term investors should also take note of this stock, which could be a pre-recovery bargain. We rate Home Depot "buy."


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