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Why Home Depot's shares aren't moving
The home fix-it chain easily beats Wall Street's expectations, but its shares fall. Until Home Depot can prove it doesn't need the housing bubble, the stock is stuck.
By Robert Walberg
The market is supposed to reward good corporate news with higher stock prices. When that correlation doesnt materialize, it's a red flag to investors.
Take Home Depot (HD, news, msgs). The home-improvement retailer on Tuesday easily beat the consensus of analysts' earnings forecasts and even posted sales that were higher than expected.
Even better, the company -- citing tight expense controls, record-high average per-customer purchases and strong growth in its service business -- boosted its sales and earnings forecasts for the full year. The company now sees fiscal 2006 earnings per share growing by 17%-18%, up from its prior outlook of 14% to 17%.
Buy a new home, or fix the old one?
Yet the stock responded to this news by going lower, not higher. What gives? Well, the stock had jumped by 15% in the month preceding todays report, so its possible that the retreat merely represented some profit-taking.
Whats more likely is that traders arent convinced that Home Depot can continue its success as rates rise and the housing market slows. Same goes for Home Depot rival Lowe's Companies (LOW, news, msgs), which Monday reported a 26% surge in profits on a 17% jump in sales. On Tuesday, its stock fell 1.26%.
The market is a forward-looking vehicle, and its only natural to assume that if the pace of new building slows so to will sales at the leading home-improvement centers.
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There are those analysts who argue that slowing new home sales is actually a positive, in that it means consumers will stay put and simply rehab their current homes -- good news for Home Depot.
However, much of the rehab business in recent years has been fueled by record-low interest rates and home refinancing. As rates trend higher, the pace of refinancing will inevitably slow. Even if that slowdown is relatively modest, it could have a big impact on the pace of future sales at home-improvement retailers.
The waiting game
This is particularly worrisome given the 18% rise in Home Depot's inventories. Clearly, the company is preparing for a strong holiday season in growth areas like appliances and power tools. But if sales slow even marginally, Home Depot will cut prices order to move inventory and that will put downward pressure on margins and profits.
At this point, all of this is speculation, as theres been little hard evidence to suggest a slowing in home-improvement spending, so dont expect Home Depots stock to get hammered in the days and weeks ahead.
Home Depot looks like a bargain. It currently trades at about 15.9 times estimated fiscal-year 2006 earnings, or at a slight discount to the S&P 500 and the industry. Valuations look even more compelling going forward, as the stock trades at only 14.2 times estimated 2007 results.
But investors won't know for sure if Home Depot's shares are a value or not until there's some real indication -- good or bad -- of how rising rates impact the home-improvement chains.
Portfolio update
Time to do some end of the year house cleaning on my StreetPatrol portfolio. My first move will be to jettison Cisco Systems (CSCO, news, msgs). The companys uninspiring earnings report last week suggests that it will spend more time struggling just to tread water and thats not good enough, so its a goner. Also, in light of the new arrangement with Yahoo! (YHOO, news, msgs) and TiVo (TIVO, news, msgs) might enjoy a momentum run that belies its underlying fundamentals which remain relatively soft. Nevertheless, I dont want to see a news-related advance wipe out my gains so Ill close my short position there. Finally, Ill close out my long position in Armor Holdings (AH, news, msgs) as earnings are flattening out and the macro economic/political climate is now less supportive.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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