Home Depot stock is a staple in many portfolios, so let's see where it stands in a challenging macroenvironment.
The housing market has cooled, along with Home Depot's (HD 0.67%) stock, but the world's largest home improvement retailer is preparing to complete an $18.25 billion acquisition of SRS Distribution, a building products wholesale distributor, to bolster its future growth.
As Home Depot shareholders wait for the deal to go through and the housing cycle to turn around, the company will continue to pay a handsome dividend. But is that enough for the stock to remain healthy? Let's examine whether investors should buy, sell, or hold Home Depot.
A look at Home Depot's financials
Home Depot recently announced its earnings results for its fiscal first quarter of 2024, showing the company generated $36.4 billion in net sales and $3.6 billion in net earnings. Compared to fiscal Q1 2023, net sales and earnings were down 2.3% and 7%, respectively.
Management, understandably, pointed to the challenges of elevated interest rates slowing down the housing market, with CFO Richard McPhail noting on the most recent earnings call: "We are seeing interest rates sort of weigh on the mind of customers. And look, we're not immune to this."
Management reaffirmed its fiscal 2024 outlook for sales to remain flat (when accounting for an extra calendar week) compared to the prior year. Despite the challenges, McPhail remains optimistic in the long term, saying, "At some point, spending on housing shifts from discretionary to something that you simply must do."
What could go right for Home Depot?
As mentioned, Home Depot plans to acquire SRS Distribution for $18.25 billion. Management believes the acquisition, expected to close by the end of fiscal 2024,can accelerate the company's growth among its residential professional customers. Specifically, Home Depot claims to currently have 17%, or $170 billion, of the $1 trillion total addressable market, and management believes this acquisition increases that stake by $50 billion.
SRS should immediately impact the company's financials, with $10 billion in net sales and $1.1 billion in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) annually.
As for when the housing cycle might reverse, the Federal Reserve recently signaled it could cut interest rates at least once in the second half of 2024. This monetary easing, combined with a recent Pew report estimating a shortfall of 4 million to 7 million single-family homes, indicates a housing market rebound is on the horizon.
While investors wait for Home Depot to return to growth, the company is likely to continue its shareholder-friendly ways of returning capital through growing dividends. The company has issued dividends since 1987 and has raised them consecutively for the past 15 years. Currently, Home Depot pays a quarterly dividend of $2.25 per share, which translates to an annual yield of 2.6%.
What could go wrong for Home Depot?
Home Depot will use cash on hand and debt to fund the SRS transaction. Considering the retailer's current net debt (total debt minus cash and cash equivalents) of $38.6 billion, the deal will cause short-term stress on its balance sheet after it closes. Specifically, management expects to pay $2.2 billion annually in just interest expenses once the transaction closes, up from $1.8 billion projected in its current fiscal year.
As a result of the acquisition, management has already paused its share repurchasing program to bolster its cash position ahead of the transaction. Notably, in its fiscal 2023, Home Depot spent nearly $8 billion on share repurchases, lowering its outstanding shares by 2.3%.
Additionally, while Home Depot's dividend is a selling point for many investors, there is a sign it's starting to cause strain. The company's payout ratio, a metric that compares the portion of earnings paid out as dividends, has climbed to a 10-year high of 57.1%. The last time Home Depot's payout ratio approached 60% was during the Great Recession when the company halted dividend increases.
Overall, Home Depot's balance sheet is more of a yellow flag than a red flag. Still, it could become crimson if sustained high interest rates and a delayed housing market rebound exacerbate its debt concerns.
HD Net Financial Debt (Quarterly) data by YCharts
Is Home Depot stock worth buying?
Home Depot stock recently traded at a price-to-earnings ratio of 23.3, slightly higher than its five-year median of 22.3, and that of its direct competitor, Lowe's, at 18.2. Given the company's track record and consistent dividends, current shareholders should continue to hold the bellwether stock. Still, prospective investors may want to wait on the sidelines until the uncertainty of the housing market dissipates and they can gain insight into how Home Depot integrates its newest acquisition.
Collin Brantmeyer has positions in Home Depot and Lowe's Companies. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe's Companies. The Motley Fool has a disclosure policy.
