I figured it would be a breeze. As a maturing company, I was going to show how growth was decelerating. Maybe I would get some help from lagging store trends as the company expanded beyond its Atlanta base. Reality tossed a wrench into my plan. Over the last four years sales growth has been consistent -- between 24% and 27% each year. Healthy same-store sales comps have helped prop up steady expansion to produce these solid revenues.
I was actually at a Home Depot last week, looking for answers. Well, that and a new shower head. Then it dawned on me. I was looking at it all wrong. It's not teetering lumber sprawled about above me. It's tumbling timber. There are two things I missed. Relativity. Tomorrow. Each of those comes with four main points. That's right. Two. By four.
Relativity
1. Home Depot is huge. It has twice as many stores as its largest competitor, Lowe's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOW)") else Response.Write("(NYSE: LOW)") end if %>. Like Home Depot, Lowe's has been the poster child for consistency. They both have 25% annualized earnings growth over the past five years. Beyond that, pick a gauge, any gauge, and Home Depot inches out ahead. Typically not by much. If gross profits are running 27% at Lowe's they're clocking in at 30% at Home Depot. If earnings are expected to grow 21% at Lowe's this new fiscal year they are looking at 23% growth for Home Depot.
No question. Home Depot is superior. But how much more would you pay? Lowe's has a market value of $18 billion. Home Depot is twice as big -- actually, a little bigger since Home Depot stores themselves are bigger -- so one would expect that somewhere in the $50 billion ballpark would make for fair relative value. Right? Keep going. $100 billion? Sorry, try the next aisle. Home Depot has a market cap of $140 billion.
2. Set aside its niche overvaluation. Let's consider the whole "category killer" architecture. It's not without risk. Remember Baby Superstore as it grew out of its infancy? How about trying Just for Feet <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FEETQ)") else Response.Write("(Nasdaq: FEETQ)") end if %> on for size? Checked out Borders <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %> lately? No, I dare not pit Home Depot against these debacles. However, these were companies where euphoria once ran larger than the leased boxes they occupied. Fragmented sectors ripe for consolidation. A trendsetter emerges. That trendsetter sets. History and sustainability are not category killer soulmates with or without lawn furniture. Even the home improvement superstore has had its casualties. Remember the K-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KM)") else Response.Write("(NYSE: KM)") end if %> spawned Builders Square?
3. We covered the hardware superstores. We covered the category killers. What about the whole retail enchilada? Home Depot is trading at 50 times year-ahead earnings. Surely there are other quality retailers that have equal if not superior track records trading at higher multiples. Let's see. Wal-Mart has done it longer, it should trade at a premium to Big Orange? No. Gap has juicier margins and a knack for landing on its khaki-decked feet. Surely its multiples are richer? Sorry. In the retail world, the valuations just don't get this high.
4. Let's try to sum up my theory of Relativity. Home Depot is clearly overvalued when compared to other home stores and even the retail sector itself. Before Bill slams me with a well-placed "Rule Makers stress the company, not the stock" let me point out how retail stocks, Home Depot included, make for weak Rule Makers when one sizes up financial performance. Low margins come with the territory. Home Depot's net profit margins fall below the 7% Rule Maker benchmark and well below the 50% height stick for gross margins. It's not just Home Depot. It is the entire retail segment that fails to meet these high standards. Home Depot does not deserve to be bid up to the rafters.
Tomorrow
1. Last week we were dealt the fourth interest rate hike since June. Home Depot has thrived in a low interest environment where cheap mortgage money has kept the home buying market afloat. For those who are not looking to pack the moving trucks the rock bottom financing rates have created attractive home equity loan rates which are tapped for remodeling. That was yesterday. With the momentum roaring towards higher and higher borrowing rates, who can argue that Home Depot will not suffer?
2. If a superstore falls in a forest does it make a sound? With 919 locations and a presence in all but two states, where do you think the next 919 units will go? It takes a mighty big shoehorn to wedge them into metropolitan markets without cannibalizing existing stores. If logic dictates that smaller prototypes can be used in smaller markets, then it follows that sales growth will also shrink. So, where is the next big orange box going to go?
3. Overseas? Why? After dabbling in Canada the company began to open international locations in 1998. Success is hardly a given. Mainstream retailers like Wal-Mart and Gap have stumbled in some global pursuits. Home Depot is an even tougher sell because it is a cultural challenge for countries to embrace our home improvement ways. Even a category killer as basic as Toys "R" Us <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOY)") else Response.Write("(NYSE: TOY)") end if %>, where it's just a big building housing tons of universal playthings, has not had a warm reception overseas. "This Old House," the popular home show that began airing just as Home Depot opened its first Atlanta store 22 years ago, has only found limited syndicated audiences abroad. It only airs on obscure channels in England and Korea. The world might crave our denim but it can craft its own plywood.
4. So, let's take all of this and toss it into a wood chipper. You have higher interest rates likely to bring same-store sales down. You have a domestic market that is on the verge of being tapped out in terms of expansion. Internationally you have fickle tastes that do not seem to align themselves with this specific steroids-fed hardware blueprint. This is tomorrow calling, Bill. Are you brave enough to answer?
This Week's Duel
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