Dueling Fools Dueling Fools: Home Depot
The Arguments

It was one of the great growth stocks of the 1990s, but now Home Depot is in a rebuilding mode. With 1,500 home-improvement stores, does the company have the tools it needs to bounce back? Not all Fools agree. Jeff Fischer (TMF Jeff) is bullish while Rick Munarriz (TMF Edible) is not. Their reasons follow in this edition of Dueling Fools.

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The Bull Argument
By Jeff Fischer (TMF Jeff)

I'm standing on the coast and hollering into the wind of a tropical storm, and directly behind this storm may be a hurricane. That's what being bullish on Home Depot (NYSE: HD) feels like. Great forces are working against this company, and it hasn't even boarded up its windows.

I'm sure that my dueling foe will outline the brewing tempests, but here's my own summary of the gloomy forecast: Same-store sales are falling by as much as 10%. Inventory soared in the last quarter. The company needs to update its stores. Its rival Lowe's (NYSE: LOW) is taking market share. Management foresees difficulty through 2003, and recently lowered guidance.

To all this, I add another concern. We recently experienced a housing boom and record mortgage refinancing, proceeds of which go into home upgrades. What follows booms? Inevitably -- eventually -- a slowdown. I believe that we'll see a slowdown in the housing market before too long. In fact, Home Depot's poor results may be a precursor to it.

So, how can I be bullish on Home Depot? How? With qualification, that's how. But don't fret. I'm still here to make the bullish case and make it loud. We have several reasons to "give it up for our Home Depot." One big reason is management.

The brass here has experience and it admits (always a good sign) that it needs to improve the business. It just outlined plans to do so. Laying out 2003 initiatives, management said it would spend $4 billion on capital investments (for 200 new stores, mostly), with $250 million going into remodeling existing stores. With 1,500 stores in the U.S., that's $166,000 per location. Since many stores are new, though, these remodeling funds will actually go much further by focusing on older stores.

A facelift should make stores brighter, "warmer," and friendlier for women, who are widely rumored to favor Lowe's. Money will also go into expanding Home Depot's relatively new professional sales business and tool rental services, both of which are quickly growing revenue sources.

Speaking of revenue growth, where's the funeral? This stock has fallen more than 50%, to record-low earnings multiples, and yet, despite a poor economy, Home Depot is still growing. Earnings for fiscal 2002, which ends in February, are expected to rise 21% to 23% on 10% sales growth. Those are still strong growth numbers, especially now.

For fiscal 2003, the company forecasts earnings growth of 9% to 14% on revenue growth of 9% to 12%. That would put 2003 earnings per share in the $1.67 to $1.74 range, on about $58 billion in sales. Both those estimates were in line with (or stronger than) consensus estimates at the time. Meanwhile, this double-digit growth just adds to a long record of consistent growth and return on equity at "the Depot." (I'm pretty cool, eh?)

Year   Sales     Net Inc.   ROE
1992   $5.1      $249     14.7%
1993    7.1       362     15.8
1994    9.2       457     16.3
1995   12.5       604     17.6
1996   15.5       731     14.7
1997   19.5       937     15.7
1998   24.1     1,160     16.3
1999   30.2     1,614     18.5
2000   38.4     2,320     18.3
2001   45.7     2,581     18.9
2002   53.5     3,044     19.4
'03E   58.5     3,348      N/A

Fiscal year ended Feb. (of year ahead); sales in billions; net income in millions.

Granted, much of this growth is driven by new store openings, which are capital intensive, and the main concern isn't really expansion (200 new stores this year is plenty). Rather, it is that same-store sales have declined. However, they declined at most retailers in the last half of 2002. Even Wal-Mart (NYSE: WMT) put up disappointing same-store sales figures. People are spending less. That happens in economic downturns. That happened in our last recession in 1990, which was the last time Home Depot's stock lost 50%.

Speaking of valuation, Home Depot is at about a 50% discount to the S&P 500's average multiple. As of Dec. 2002, the S&P 500 traded at 28 times trailing earnings, including all companies without earnings, and 19.4 times earnings excluding the companies without earnings. At $21 per share, Home Depot is at 13.5 times its past 12-month earnings, and 12.6 times its most conservative 2003 estimate.

Now, for a retailer growing up to 12% a year, that valuation may sound just about right. But Home Depot isn't just any retailer. It leads a large, important market in North America, has plenty of opportunities, and will almost surely command a multiple above its growth rate again when investor confidence returns. And that's why investors who are interested in retail (which is not for the faint of heart) would invest in Home Depot now: Much less downside risk and good potential for a rebound.

Jeff Fischer didn't ding your car. Side with him. He doesn't own shares in any of the home-improvement chains mentioned here. Jeff's stock holdings can be viewed online, as can the Fool's disclosure policy.

The Bear Argument
By Rick Aristotle Munarriz (TMF Edible)

Between the blue lights, the golden arches, and the orange aprons, investing in the retailing giants of yesterday can be enough to make a prospective shareholder go colorblind. Yep, Home Depot is pretty much where McDonald's (NYSE: MCD) was last year and Kmart a couple of years before that in terms of coming to grips with its new lack of relevance. It stings. It doesn't sink in at first, even as the stock keeps sinking.

Owning shares of Home Depot has been like watching paint dry. Red paint. The stock was the worst-performing Dow component last year, shedding a little more than half its value. Here we are with the refinancing boom in full swing as mortgage rates are at a 50-year low and construction peaks as new housing starts hit a 16-year high last month. Meanwhile, Home Depot is whiffing away as it swings at these juicy softballs.

"We have embarked on a transformation for the Home Depot from a young, decentralized business toward a more mature and balanced company with predictable and sustainable growth potential," CEO Bob Nardelli announced two weeks ago.

Somewhere between the screws and the nuts, it seems as if Nardelli managed to find a box chock full of euphemisms. So now being "young" and "decentralized" is a bad way of saying "growing," while "mature" and "predictable" and "sustainable growth" are just his way of dropping anchor. Nardelli actually made this remark as Home Depot was lowering its 2003 sales and profit targets. So, how is this predictable and a sign of sustainable growth? Let's not confuse maturity with denial. 

Home Depot announced a $4 billion makeover that will add new stores and spruce up existing locations. This sounds a lot like the lavish yet ultimately flawed spending sprees launched by McDonald's last year and Kmart before that to try to reinvent their tired formats. It's like going in for a tummy tuck because your feet are wrapped in cement. Vanity kills -- and it isn't cheap, either.

I've got a cheaper idea to save Home Depot. Just replace all of its orange and white Home Depot signage for the blue and white splendor of Lowe's (NYSE: LOW) signs. There. I said it. Lowe's is eating Home Depot's lunch with its bright, airy stores that appeal strongly to both sexes. When Home Depot blamed everything short of its own incompetence for its projected 10% decline in comps this past quarter, you probably came to the logical conclusion that it was a load of Sheetrock. Lowe's was doing just fine. The mom-and-pop hardware shops that Home Depot's grandeur alone would bulldoze away in the past were holding their own. It was just one big company stuck with 1,500 stores fading in patron popularity.

While I'm sure Jeff just presented you with a dandy of a valuation argument, it's important to keep things in perspective. Just because the stock hasn't traded this low since 1998 doesn't make it cheap. Even Home Depot is projecting a lack of same-store sales growth in the near term. This is not a situation with a quick fix. Unfortunately, Home Depot doesn't have a whole lot of time.

With Lowe's expanding into Home Depot's core markets, it's only going to get worse. It's also going to get more crowded. A Sanford Bernstein study sees the home-improvement superstore market fully saturated by next year.

So it's no wonder that after clinging to the prospects of growing earnings by as much as 20% annually, Home Depot is now warning investors to look for earnings growth this new year to be shaved nearly in half.

Shaving things in half is not a new concept here. The stock is fetching half as much as it did when Nardelli came to Home Depot from General Electric (NYSE: GE) two years ago. He was a manufacturing guru and a master of operations, and, while that may have served Big Orange well in improving its operating efficiency, he hasn't done the company any favors by being a marketing dullard. 

Folks are remodeling their refinanced homes, yet Home Depot is losing ground. Contractors are busy with new construction, yet Home Depot is suffering double-digit percentage defections. It doesn't make sense. I wish I could storm into my nearest store and find a bucket of screws. I'd stick my hand in, swirl it about, and come to the conclusion that the company's got a few screws loose and that would be it. Unfortunately, it's a much bigger problem than that. Home Depot went in for the tummy tuck when all it really needed was a facelift.

But it's too late for all that now. The company is too big to make the necessary nimble moves and its brand's ubiquity is postmarked tired.

Where is the rainbow? Where are the rose-colored glasses? The sad truth is that, when you're color-blind, there is no silver lining.

Rick Aristotle Munarriz thinks that Home Depot is ugly and that its mom dresses it funny. He does not own shares in the home-improvement chain, and he never has. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.

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