- In the early hours of February 21st, Home Depot reported robust F4Q16 results.
- Solid opex management helped to convert top-line momentum into impressive EPS growth.
- Management surprised with an increase in the dividend payout policy that can be interpreted as both good and concerning news.
In the early hours of February 21st, Home Depot (NYSE:HD) reported robust F4Q16 results. Revenues of $22.2 billion beat expectations and grew nearly 6% YOY. Better yet, EPS of $1.44 was 23% better than last year’s earnings, and exceeded consensus by a wide 11-cent margin.
Profitability improvement magnifying top-line momentum
I was impressed not only by Home Depot’s top-line performance, but particularly by how well the company managed its costs below the gross profit line. The unexpected 6% revenue growth alone might have been satisfactory enough, but flat SG&A (selling and general expenses) suggests to me that management has done an outstanding job squeezing value out of the business.
Op margins in the quarter improved by more than 100 bps YOY, despite gross margin having deteriorated over the same period by about 10 bps. Home Depot’s aggressive cash return policy impacted share count as well, which helped to turn a 19% YOY net income improvement into 23% EPS growth.
Surprising dividend hike
Notable this morning was management’s decision to adjust the company’s capital allocation strategy, resulting in an increase in the dividend payout ratio from 50% of net earnings to 55%. The dividend payment for the upcoming quarter will be raised 29% to $0.89/share, likely catching most investors and analysts by surprise. The yield will increase to 2.4% from 1.9%. In addition, the board of directors authorized a $15.0 billion share repurchase program.
Ordinarily, I would see an unexpected dividend increase and boost in share repurchase authorization as great news. In fact, the stock’s +2.5% pre-market reaction could be in part reflecting management’s bold move, considering the company’s guidance for FY17 largely met Street expectations.
But I am somewhat concerned about Home Depot’s high levels of debt, which reached a whopping $23.1 billion this quarter (vs. $21.1 billion last year). A net earnings payout ratio of 55% may seem conservative enough, but notice how total cash returns to shareholders in fiscal 2016 represented 125% of FCF (free cash flow) generated. With the changes in the capital allocation policy, this ratio is only expected to increase in the next several quarters.
While I don’t see imminent liquidity issues, I question whether Home Depot, very much unlike Wal-Mart (NYSE:WMT), might be taking too aggressive a stance on cash distribution.
Home Depot posted outstanding F4Q16 numbers and guided for an in-line fiscal 2017. Those looking to invest in the stock of a company expected to grow at a much healthier pace than the average retailer while being priced much less aggressively than e-commerce names like Amazon (NASDAQ:AMZN) might want to take a closer look at HD.
I am a bit concerned, however, about Home Depot’s debt levels. In the absence of macro headwinds that could range from economic slowdown to border tax policy, I believe the company should be able to meet its expectations for 2017 and properly support its capital allocation plans. But I sense some risk in the air, and I question whether the stock’s 20.3x forward P/E might be reflecting the potential challenges properly.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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