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Home Depot Delivers, But Expectations Rise

Home Depot's earnings report suggests a turnaround, though the real test will be if revenue can meet the company's own forecasts.

BOSTON (TheStreet) -- Investors expected strong fourth-quarter results when Home Depot (HD) - Get Home Depot, Inc. Report released its report today, and the retailer delivered.

Smaller competitor


(LOW) - Get Lowe's Companies, Inc. Report

yesterday posted profit that beat analysts' estimates as sales fell less than its own forecast.

Unlike most retailers, Home Depot gets the majority of its sales in the spring as homebuilding ramps up as temperatures warm. Despite the heavy weighting of springtime sales, Home Depot gets brisk sales in the South and West, where winter isn't as cold. But this year was colder and snowier than most, slowing the pace of sales. Some analysts have suggested that sales of salt, heaters, snow shovels and snow blowers offset losses from construction, and while that may be partly true, the increase in cold-weather supplies had to have been substantial to cover the losses.

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Revenue in the fourth quarter of 2008 dropped by about $3 billion, accounting for half of the year's decline. Still, sales in the most recent quarter were projected by analysts to fall, despite the low base of a year earlier. Analysts expected the company to post earnings per share of 17 cents on revenue of about $14 billion. The company had earnings of 24 cents a share on revenue of $14.6 billion, besting last year's results which featured earnings of 19 cents per share on similar revenue.

The stock price of about $30 suggests a bullish turnaround in the housing market. While Home Depot is a strong company financially, the share price probably won't see much justification for a further rise in 2010 unless earnings continue to be strong despite the expiration of the first homebuyer tax credit. The company also increased the dividend to 5%, which should bolster the price at its current level.

The major event on the horizon for Home Depot that has many investors worried is the expiration of the new-homebuyer tax credit in April. Some fear that when the credit disappears and the market is forced to stand on its own two feet, there could be another slide in home prices. That could trigger more volatility in the market as homeowners holding on to a small sliver of home equity either walk away or are unable to sell as buyers suddenly disappear.

Home Depot's underlying fundamentals are appealing. A freshly increased dividend yield of 5% and a beta value of only 0.63 make the stock look stable, but a return on equity of just 12.3%, a price-to-earnings ratio in the mid-20s, slight profitability and a high stock price are barriers.

Lowe's has had a much more understated advance over the past year. As Home Depot gained more than 50%, Lowe's tacked on 36%, keeping its P/E ratio in the high teens. As a result, Home Depot looks expensive compared with Lowe's, and the prospect of outsized returns for Home Depot seems far-fetched.

There is much more to an earnings release than year-over-year comparisons and beating analysts' expectations. Company management has to do a good job of foretelling the anticipated direction of sales in the coming year. With the unease in the housing market, that was a tough sell. Management projected sales growth of 2.5%. Given the uncertain nature of the next few months in the housing market, that projection will be highly scrutinized.

Prior to joining Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.