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As Home Depot buys, investors should wait
The home-improvement retailer is on an acquisition spree, trying to soften the blow of a housing slump. But rising rates may slow Home Depot's new and old businesses.
By Robert Walberg
A couple of months ago, I suggested that investors were concerned that a slowdown in the housing boom would translate into slower sales growth for Home Depot. These fears helped explain why the stock reacted negatively to better-than-expected quarterly earnings.
Apparently, Home Depots (HD, news, msgs) management was concerned, too. As proof, check out the cool $3.2 billion Home Depot is paying to acquire Hughes Supply (HUG, news, msgs), a leading construction supply distributor. The deal came one day after Home Depot gobbled up Chem-Dry, a chain of carpet and upholstery cleaners, for an undisclosed sum.
The Hughes deal is the largest acquisition in Home Depots history and its fourth in the last 12 months. Management is not waiting to find out if rising interest rates will slow the home-improvement business. Home Depot is diversifying its operations, a good way to reduce exposure to any one segment of the market.
Lacking Wal-Mart's muscle
For that, CEO Robert Nardelli is to be applauded. However, before getting too excited about the recent string of purchases, remember that Home Depot is branching out into areas that sport lower margins and that arent easily dominated by one player.
Take Hughes business. With nearly 500 locations in some 40 states, Hughes is considered to be one of the premier players in the construction supply business. Even so, its $5.2 billion in sales is only a small slice of the $400 billion construction supply pie.
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By bringing Hughes into the fold, Home Depot nearly doubles the size of its supply business. But $12 billion is still only about 3% of the overall market. Yes, the addition of Hughes gives Home Depot increased leverage in the space, but it does not come close to giving the company enough share to flex its muscle the way Wal-Mart Stores (WMT, news, msgs) does with many of its suppliers.
The acquisition does reduce Home Depot's reliance on its retail stores, but it does not help insulate the company from the interest-rate risk that concerns investors. If rates climb -- especially on the long-end -- then the construction business will almost certainly slow, leading to reduced demand for supplies. Higher rates will slow the use of home-equity loans and mortgage refinancing, both of which have fueled home improvement sales.
Give Nardelli credit for expanding Home Depot into markets with big growth potential. Maybe Home Depot will continue gobbling up small supply companies until it achieves enough scale to seriously improve operating efficiencies. Nardellis vision might even enable Home Depot to continue posting double-digit growth rates investors crave.
Faster growth, or bigger mess?
But we don't know yet whether the company will have the same success in the supply business as it has in retail, and we dont know if the lower margins from the supply business will adversely impact margins and long-term profit growth.
Home Depot says the Hughes acquisition will be accretive to earnings within the first year by enhancing overall operating effectiveness through scale, simplification and knowledge transfer. Whatever. Actions, and in this case numbers, will speak louder than words. I, for one, am willing to wait it out and see if Home Depots acquisition spree translates into faster growth, as management promises, or into an unfocused, distracted mess. The latter is often the fate of companies with overly aggressive acquisition strategies.
Home Depots stock has spent more than a year trying to get back to its late 2004 high of $44.30 -- this during a period in which interest rates were low and housing and construction have boomed. Dont let the deal buzz force you into any rash investment decisions. With Home Depot, the best approach is to make the company prove there aren't any cracks in the foundation before buying in.
Update on Apple
For those of you that think Im a Microsoft pawn, or just an idiot, for suggesting selling Apples stock after the hype created by the MacWorld conference, let me take a moment to say that I'm neither. (Well, definitely not the former with the jury is still out on the latter.) The advice to sell Apples stock stands. The stock is richly valued at current levels, Apple is facing increased competition on a variety of fronts from well-capitalized, well managed companies, and expectations on the Street are so high that even Apple will have a hard time living up to them (especially considering point two). These arguments were not altered by the usual dynamic performance given by Steve Jobs at yesterdays MacWorld conference. To the contrary, the usual pop in the stock in reaction to Jobs presentation simply provides a more compelling exit point. You might be leaving 20% on the table, but as my daddy always told me, pigs get fat, hogs get slaughtered.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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