Buy the Dip in Home Depot, But Wait for It to Bottom First

Key Points

• Home Depot had a decent quarter, but guidance is iffy and suggests core business will weaken in the second half of 2024. 
• The acquisition of SRS drives value for shareholders but results in a slowdown in repurchases that may not pick up soon.
• Home Depot shares are trapped in a trading range and may move lower before they move higher, providing entry for new money. 

Home Depot NYSE: HD is a high-quality business in no danger of failure, but its stock price will likely head lower now that the Q2 results and guidance are in. The guidance was improved, but factors including acquisitions, organic declines, and cautionary statements raise serious doubts about the results for the next two to four quarters. Doubts and questions about economic health will likely pressure this stock’s price and other consumer discretionary names because the market is forward-looking. That situation is unlikely to change until after the FOMC makes its first interest rate cuts, the soft economic landing is more assured, and the outlook for organic business growth improves. This market will form a technical bottom between then and now and signal it’s time to buy. 

Home Depot Has Beat-and-Raise Quarter: Signals Turbulence Ahead

Home Depot had a decent quarter because of the diversifying business model and acquisitions rather than core strength. The company reported $43.2 billion in net sales for a gain of 0.7%, which beat the consensus reported by MarketBeat by 115 basis points. However, comp sales are down 3.3% systemwide and 3.6% in the U.S., offset by the addition of SRS. SRS is a building material supply distributor acquired earlier in the year; it added $1.3 billion in revenue worth about 300 basis points, which is why revenue grew. 

Comps are up sequentially due to seasonally expected spending habits but down YoY on a 1.8% decline in transactions compounded by a 1.3% decrease in average tickets. Also, comps have been negative for nearly two years, and transaction size is near a two-and-a-half-year low, with guidance expecting continued pressure on consumers for the foreseeable future. 

The margin news is mixed and shaded by the guidance. The operating margin came in better than expected but was insufficient to offset the top-line weakness, even with a lower share count. Operating margin contracted by 30 basis points to 15.1%, leaving the adjusted EPS at $4.67. The $4.67 is $0.12 or 260 bps above consensus but down a penny compared to last year. 

Guidance is why the market for HD moved lower after the release in premarket trading. The company raised its guidance for revenue by 200 basis points at the mid-point but reduced its expectations for comp-store sales and earnings. The increased revenue outlook is due primarily to the SRS acquisition. The expected 3% to 4% contraction in comp sales is 250 bps worse than the prior guidance and includes negative earnings growth versus a 1% increase.

The worst news is the CEO's comments, which mention high interest rates and macroeconomic pressures impacting consumers and their growing uncertainty. With this in play, investors should expect to see the core business weaken as the year progresses. 

Home Depot’s Financial Health Improves: Repurchases Slow to a Trickle 

Home Depot’s financial health improved over the last year, aided by the acquisition of SRS. The net impact is a negative cash-flow quarter, a reduction in net cash, and increased debt and liability offset by increased assets and shareholder equity. Equity is up 26% and likely to continue growing. 

The critical detail is that the cash reduction led to a slowdown in share repurchases that may linger for the next few quarters. Repurchases over the last year reduced the average diluted count by 1%, but the total in Q2 is down 86%. Management may choose not to increase the pace to rebuild the cash position and address the increase in debt, which is a good thing but will weaken the tailwind buybacks provided. The dividend is safe and likely to grow if growth runs slower than the 12% CAGR it now runs. 

Home Depot Shares Are at a Critical Turning Point 

HD shares are down in premarket action and at a critical turning point that may lead to lower prices. The market is struggling to support the stock at $345, which coincides with an important pivot point that has impacted price action since early 2021. If the market can not continue to support the stock at this price, there is a danger it will fall to $320 or lower before rebounding. Even if the market can support the price at $345, HD stock will likely move sideways within its trading range for the foreseeable future.