Home Depot's Profitability Remains Solid

We don’t plan to materially alter our $220 fair value estimate for wide-moat Home Depot HD and view shares as rich, even after a mid-single-digit post-print decline. Investors focused on the company’s slower same-store sales pace in its second quarter, with 4.5% comp growth down materially from the 31% comp it posted in its first quarter. We had forecast a more severe slowdown (with estimated comp performance of 0%), as the company lapped a healthy 23% figure in the second quarter of 2020, but the return of pro sales (at the expense of DIY) helped lift demand more than anticipated. The gross margin of 33.2% was 60 basis points lower than we expected, but the metric saw 60 basis points of pressure from lumber prices during the period, largely accounting for the change. Operating expenses, however, were 90 basis points better than we expected, at 15.6%, as COVID-19-related costs receded from year-ago levels. All in, this led to an operating margin of 16.1%, 60 basis points ahead of our projection and the highest quarterly profit metric since second-quarter 2018. Looking forward, we surmise some selling, general, and administrative scale gains will cede as Home Depot’s top-line growth normalizes. In the near term, the remainder of 2021 could see little operating margin leverage, and as such, we model 13.5%-14% operating margins for the second half of 2021. As the economy continues to reopen, consumers could continue to reallocate their discretionary spend (restaurants and leisure, for example). We incorporate negative mid-single-digit comps over the rest of 2021 as the firm laps the achievement of mid-20% metrics in the back half of 2020. Longer term, we forecast roughly 15% operating margin performance (versus 14% in 2020), which is bound by Home Depot’s competitive pricing strategies and continued spend to elevate the brand and maintain its market leadership position. Such efforts are likely to hold ROICs in the mid-30% range over the next decade by our calculation.

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