Skip to main content

Home Depot Gets Footing on Shaky Ground

Home Depot's shares have roared back, but the retailer for do-it-yourselfers is still stuck in a soft homebuilder market.

NEW YORK (TheStreet) -- The Home Depot (HD) - Get Free Report, tied tightly to the housing market, was caught in the undertow of the real-estate crash and financial crisis.

With the government's support in offering homebuyer tax credits, purchasing mortgage securities and adjusting loan rates, housing has gained its footing, and so, too, has Home Depot. Home Depot's shares tumbled by half to $17 last year and have since rocketed to about $30.

Analysts expect strong fourth-quarter results when Home Depot releases its report today. Smaller competitor


(LOW) - Get Free 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.

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 are projected by analysts to fall, despite the low base of a year earlier. Earnings per share will decrease to 16 cents from 19 cents 12 months earlier, according to analysts.

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 rebound and revenue surprises.

The major event on the horizon for Home Depot that has many investors worried is the expiration of the new-homebuyers 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 dividend yield of 3% 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 will have to do a good job of foretelling the anticipated direction of sales in the coming year. With the unease in the housing market, that will be a tough sell.

-- Reported by David MacDougall in Boston.

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.