Interactive Investor

Time to buy this industry leading stock again

Up almost 10% since he last tipped this company, overseas investing expert Rodney Hobson thinks a recent pullback presents another buying opportunity.

20th September 2023 10:02

Rodney Hobson from interactive investor

    The United States economy is holding up better than expected, inspiring consumer confidence and raising hopes that the world’s largest economy will avoid recession. However, the brighter picture has not yet filtered through to all retailers.

    US retail sales rose 0.6% in August, beating forecasts and more than wiping out the 0.5% fall in July. The August figure was admittedly inflated artificially by higher global oil prices feeding through to the petrol forecourts, but even the more modest underlying improvement of 0.2% was better than economists had predicted.

    Unemployment in America remains low, inflation is easing, and the run of interest rate rises is tailing off. Real consumer spending looks likely to show an increase again in the third quarter, despite fears that the pile of cash saved during the stay-at-home days of the Covid epidemic is running out and a moratorium on repaying student loans is due to end.

    Some retailers such as Walmart Inc (NYSE:WMT) and McDonald's Corp (NYSE:MCD) have fared well since the epidemic, but one surprising laggard is The Home Depot Inc (NYSE:HD), which specialises in home improvement products including building materials, gardening and decorating plus tool and equipment rentals.

    Second-quarter revenue slipped 2% to $42.9 billion, a trend that even the company itself expects to continue for the rest of the year. A bigger worry is that net earnings dropped 9.9% to $4.66 billion and are set to be between 7% and 13% lower for the full year. It could be next year before less demanding comparatives allow the first signs of improvement.                             

    The problem is that while customers are going ahead with smaller projects, they are postponing – or possibly dropping – big ticket items. Consumer confidence clearly does not run to spending where discretion is the better part of value. 

    The shares peaked at $415 at the end of 2021, when home improvements were keeping consumers sane during the sporadic lockdowns. Business in the sector has reverted to more normal levels and the shares are back down to around $313, where the price/earnings (PE) ratio is still a little toppy at just under 20. At least there is a reasonable if not overexciting 2.6% yield, and the shares should be supported by a new $15 billion share buyback.

    Source: interactive investor. Past performance is not a guide to future performance.

    Home Depot is not alone among home improvement chains in struggling to keep sales stable post lockdowns. UK-listed Kingfisher (LSE:KGF) has just reported first-half setbacks, particularly in France and Poland. Yet this is a sector that, despite the occasional, mainly modest takeover, remains highly fragmented, and the strong will come through in much better shape than the smaller players.

    As the world’s largest home improvement retailer, Home Depot is rightly confident of growing market share. The squeeze on homebuyers through higher mortgage rates could actually help the company, as aspiring homeowners choose to improve their existing properties rather than move into more expensive ones.

    Hobson’s choice: The shares have fallen heavily of late but should stabilise soon. Cautious investors may wish to wait until it is certain that they have levelled off, but Home Depot rates a buy at current levels. Those who followed my advice in May last year to buy at $287 will be well satisfied.

    Update: I said a month ago, when its shares were at $157, that it was not too late to buy into retail giant Walmart as it would surely set a new high above $160 soon. They have since reached $165 and, although they have eased back a little from that peak, I would advise shareholders to hold on even though the PE is a little daunting at 31.4 and the yield less than convincing at 1.4%. If the shares slip below $160 again then consider them a buy.

    Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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