Home Depot (HD 0.02%) was undoubtedly a major beneficiary of the coronavirus pandemic, as people who were spending more time at home quickly turned to renovation projects. But with the threat of a potential recession looming, shareholders are considering making changes to their holdings to better position their portfolios for what might come.
If you're split on what to do with your Home Depot holding, continue reading to find some more clarity about the bull and bear arguments.
A resilient business model
One of the most attractive traits about investing in Home Depot is its generous capital-return policy. Since the start of fiscal 2020, the business has paid out $19.4 billion in dividends and repurchased $20.7 billion of its stock, which equates to 12% of the current market cap of $336 billion. Only companies that produce copious amounts of free cash flow can even come close to considering this kind of corporate action.
Shareholders benefit from added financial gains. Dividends provide a steady stream of income for investors who prefer such a thing. And share buybacks boost earnings per share, helping long-term owners with a potentially higher stock price over time.
Bulls could also point to Home Depot's dominance in the Pro segment. These customers include vocational experts like general contractors, plumbers, electricians, and the like who lean on Home Depot as a mission-critical partner for their own small business operations.
It is estimated that Home Depot generates about half of its overall revenue from Pros, far greater than the 25% revenue split that Lowe's (NYSE: LOW) has. This means that in the most recent fiscal quarter, $19.5 billion of Home Depot's sales came from Pros, compared to $5.9 billion for Lowe's. That's a wide margin.
This favorable situation benefits Home Depot in three different ways. First, it results in better financial metrics. Home Depot consistently posts a higher operating margin and return on invested capital than its smaller rival. Additionally, these professionals can be far more loyal customers than DIYers. DIY customers might shop around for the lowest possible price, whereas a Pro would do business with the retailer that it has a long-standing relationship with, taking advantage of financing options and exclusive offers.
Lastly, and probably most pressing right now, having more Pro customers supports Home Depot in an economic downturn. Pros are hired to tackle bigger and more complex renovation projects, usually from higher-income households that are less affected by recessionary worries.
Tempered growth expectations
Home Depot's business is holding up well right now. And management expects same-store sales to increase 3% in fiscal 2023 (ends Jan. 29) compared to 11.4% in the prior year. That's not too shabby when you take into account the company's growth in recent years and the current macro picture.
But what if the U.S. enters a full-blown recession later this year? JPMorgan Chase CEO Jamie Dimon predicts that the combination of high interest rates and inflation will swing the economy into recession in 2023. The implications for the housing market must be thought through. A severe and prolonged recessionary period will definitely hurt Home Depot's prospects, at least temporarily.
As I touched on earlier, Home Depot's Pro business is a nice cushion. But this doesn't make the company completely immune. During the Great Recession, Home Depot's annual revenue dropped 7.8% and 7.2% in fiscal 2008 and fiscal 2009, respectively, as a consequence of the subprime mortgage crisis. I'm not saying things are as dire now, but this should be on shareholders' minds.
Shareholders must also think about changing consumer spending patterns. Flush with extra cash and limited on what they could spend on, households focused on upgrading their living quarters during the pandemic lockdowns. This behavior could be a thing of the past now.
Leisure and entertainment activities could bounce back, especially travel. Passenger traffic in the U.S. appears to have reboundedto pre-pandemic levels. And according to data from consultancy Deloitte, consumer spending on discretionary purchases increased at a faster rate than any other category in October (the latest data available).
The mid- to high-teens revenue growth we saw from Home Depot in fiscal 2020 and fiscal 2021 could prove to be a huge pull-forward of demand, meaning slower gains in the years ahead that are below historical norms.
