Home Depot May Have Value In The Long Term:

• Stock is down over 33% from its high.
• Home Depot benefitted from pandemic spending.
• Higher interest rates and consumer spending may force the stock down further.
• Store count 2316 with a total of 240 million in square footage.

Home Depot (NYSE: HD) is down significantly from its 52-week high and may have peaked for now. The company benefited from the pandemic as most of the population took advantage of being home-bound to work on home-related projects such as painting, remodeling, and replacing old appliances. The stock is down (-33%) from its pandemic high and is facing multiple issues, including a broader economic slowdown on the horizon and rising interest rates both of which are weighing on the stock.

Home Depot historically has been a mixed bag, falling somewhere between consumer discretionary and a consumer staple stock. The stock tends to perform better than typical consumer discretionary stocks but underperforms the broader consumer staple market.

Home Depot primarily caters to are contractors, but with the housing market slowing down, home and construction-related activity pulling back, contractors may reduce their spending.  As a result, the current environment is not conducive for the stock, but the long-term fundamentals make the stock an interesting consideration.

Home Depot’s outlook in 2022

The housing market continues to slow down as the fed raises interest rates. The 10-year Treasury rose to over 3.4%, with the latest inflation reading coming in hotter than expected, and mortgage rates have now hit over 6%. As a result, home prices have already shown weakness, with key markets witnessing a decline. Analysts believe many regional markets within the U.S. could see anywhere from a  15-20% decline in prices, which would undoubtedly weigh on demand for Home Depot’s products as consumer sentiment turns cautious. Furthermore, consumer sentiment continued to be weak, and with the latest report showing a reading of 50.2, consumer companies may too in turn witness a slowdown in revenue.

Earnings and Valuation

EPS was up by $4 per share for the first quarter, 6% higher than the same quarter in 2021. Meanwhile, revenue came in at $38.9 billion, up 4% y-o-y.  Gross margin was essentially flat at 33.8%, and operating margin too was flat at 15.6%. However, margins pressure may come down in the coming quarters as some of the costs are offset by management, which could result in operating margins rising above 16%.

Home Depot certainly isn’t cheap; at 17x earnings and revenue potentially turning negative in the latter part of the year, the stock could come under further pressure hitting new lows. Analysts currently estimate revenue could come in around $156 billion for the year, which would translate into an increase of 2.5% from 2021. Although 2.5% is low, it could go lower as demand witnesses a pull-back.

Future of Home Depot

Homeownership rates climbed by over 1.5% over the past couple of years as more and more people sought out home ownership instead of renting. With mortgage rates rising to levels not seen since 2006, home ownership has become much more expensive, and unless home prices come down (which they should), demand for housing will likely remain low for a while. In addition, mortgage default rates are starting to climb as well, especially in the sub-prime category. Although sub-prime mortgages as a percentage of total mortgages are down from the last major recession in 2008, rising defaults are still problematic. Beyond that, housing prices will probably have to correct 25-30% from their recent highs for buyers to return to the market in any meaningful way. Overall, the housing and housing goods-related market is likely to remain subdued for a while.

Management’s Outlook

Home Depot’s management continued to re-iterate that home improvement backlogs remain strong and that the market has a tremendous forward outlook. Home Depot is currently focusing on improving connectivity by increasing distribution centers as it looks to improve operational efficiency and profits as management targets contractors through its new warehouses. The strategy of building what is known as flatbed distribution centers could pay off in the long term as more local access helps bring in incremental revenue.

Should you consider Home Depot?

Home Depot’s stock faces multiple drawbacks as it looks to manage a macroeconomic environment that is unprecedented. Although the stock should hold up better than many of the stocks within the broader market, it is still likely to come down further in the short term. Nevertheless, the stock remains a relatively robust defensive play over the long term. Should the stock correct further, it may have value and could find itself a part of a defensive portfolio.