How You Can Make 10X The Return From Home Depot
Renovations and home flipping are no longer a rare hobby only available to deep-pocketed “house flippers.”
In fact, as interest rates, economic activity and population densities grow, affordable housing is becoming less common. These trends have led more and more people to buy fixer-uppers (even if consumers have no idea how to fix them up).
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The current rise in “flipping” isn’t like the Wild West days of 2004-2007. Most house flippers learned their lessons during that time and are now more conservative with their borrowing and expectations. And thanks to growing interest and coverage of the topic from the likes of HGTV and many more media outlets, Americans are better prepared. If done correctly, flipping houses can make for a decent living.
Of course, Home Depot (NYSE: HD) is poised to take advantage of this growing trend. One way the company has set itself apart is by staffing its stores with knowledgeable, seasoned pros. Unlike its No. 1 competitor, Lowe’s, which typically hires from the general labor pool, Home Depot has made it a major goal to ensure it has the best staff to help consumers and align itself with pros who can get the job done right.
#-ad_banner-#Speaking of, HD also caters directly to pros, offering a greater selection of commercial grade materials, raw lumber, tool rentals and more. Last year, 40% of Home Depot’s revenue was driven by pros… who will keep coming back with each next project.
With the company’s quiet acquisition of Interline Brands — a direct marketer that distributes more than 150,000 hardware products from HVAC to ceiling fans, cleaning products and connectors — it can now profit on the sale of maintenance and repair items to pros who service and repair homes.
The deal is sure to boost Home Depot’s future earnings, but the benefits are grossly underestimated in my opinion.
On the consumer side, Home Depot is fostering relationships with those same pros to help regular consumers with their projects directly through its “Home Services” division and indirectly with companies such as Home Advisor, which helps consumers price and schedule home improvement projects.
The company is also expanding its home furnishings division, utilizing its e-commerce strength and existing footprint to add to sales.
Home Depot is firing on all cylinders. After a record second quarter, management upped their earnings guidance, suggesting 13% EPS growth for FY 2017, nearly double the 6.9% earnings growth that the S&P 500 has logged thus far.
And the best seems yet to come…
Tax Reform And Growing Margins Should Benefit HD
The initial iteration of Trump’s tax reform bill will surely put more dollars in Americans’ pockets (House GOP leaders say it would save the average family of four nearly $1,200), but some investors saw the potential cap on mortgage deductions as a detriment, and sent shares of Home Depot lower. But they’ve got it all wrong.
The House bill’s mortgage cap would mean that only homebuyers with mortgages worth $500,000 or less could deduct the mortgage interest payments. (Currently, the cap is mortgages up to $1 million.) But even with the average U.S. home selling upward of $370,000, the mortgage cap is still well above that number. And for those Americans who can afford homes costing more than $500,000, renovation costs typically aren’t an issue. And if they want to save money, they too would be directed to Home Depot.
To me, the potential $1,200 gain per family would far outweigh any caps on mortgage deductions.
What’s more is that Home Depot has been breaking revenue and earnings records for a couple years now, bucking the weak retail trend. And the company did it differently.
For nearly three years, the company has basically halved the number of new stores it’s opened. Instead, its focus has been turning up margins and making its existing network extremely efficient. That means Home Depot can still resort to opening new locations if growth in other areas slows — in other words, it has a lot of dry powder.
Since last quarters’ results didn’t even factor in the positive effects the tax cuts would likely provide, you can expect the coming quarters’ guidance to reflect the potential $1,200 windfall for the average American family. With 81 million families, just an additional $100 spent at Home Depot per year would equate to an $8.1 billion windfall, or a 9% gain in overall revenue, which was $94.6 billion in 2016.
The broad fundamental picture is improving for Home Depot. Even if the real estate market slows a bit, consumers would likely be more motivated to spend on improvements to make their property stand out or make it more of a long-term home. Either is good for HD’s share price.
Furthermore, I believe we’ll also see shares continue higher. My target price for HD is $172 before year-end, which is only 2.6% above the stock’s recent highs. And I’m not the only one keeping my eye on this price… Many other analysts are also pinpointing this level, with a consensus target of $171.64.
With shares currently trading right around $164, a climb to $172 would represent a return of 4.8% in HD. However, while buy-and-hold investors are boasting about their 5% gain, we can amplify that win nearly 10-fold by buying calls. With the specific options trade I recently recommended to premium readers of Profit Amplifier, a 4.8% increase in the stock’s price would give us a 47.8% windfall in just a few months.
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