Investors were bracing for some weak operating results out of Home Depot (HD 0.02%) this month, and that's exactly what the retailer delivered. Home improvement demand is clearly shrinking following three years of strong growth, its first-quarter earnings report showed. And deflation in some key categories is harming profitability, too.
Investors have to balance the short-term risks against Home Depot's attractive qualities, including its market dominance, its growing dividend, and its impressive cash generation. With that big picture in mind, let's look at whether the stock is a buy, sell, or hold right now.
A surprising slump
The headline takeaway was that growth was surprisingly weak through late April, just as Home Depot's crucial spring selling season began. On the bright side, declines in customer traffic improved to 5% from 6% in the prior quarter. The retailer has been leading the industry on this metric lately, in part thanks to its strength among professional contractors.
But average spending was flat, marking a sharp slowdown from the prior quarter's 6% increase. Management cited a few temporary pressures, including dropping lumber prices and unseasonable weather. But the first-quarter growth momentum still disappointed. "We observed more broad-based pressure across the business compared to when we reported fourth-quarter results a few months ago," CEO Ted Decker said in a press release.
Reducing expectations
The worse news for shareholders came in the form of Home Depot's updated 2023 outlook. Management is no longer calling for roughly flat sales compared to last year's 3% uptick. Comps are now predicted to decline by between 2% and 5% instead.
HD operating margin (TTM) data by YCharts. TTM = trailing 12 months.
The company forecasts that its world-class operating margin will worsen, too, landing between 14% and 14.3% of sales compared to the prior target of roughly 14.5%. Executives cited a "more challenging environment" that's developed in the weeks since Home Depot issued its official 2023 outlook in late February.
These results will still likely keep the retailer ahead of most peers in the home improvement industry. Rival Lowe's (LOW -0.03%) posted weaker profitability and customer traffic metrics in fiscal 2022, after all. But the next few quarters could be tough, with an industry recession still possible.
Price and value
You won't find a retailer that's immune to recessions, which are a normal part of the industry. Yet the start of a slowdown like this still raises fears about the depth of the approaching downturn. Those worries are the main reason Home Depot's stock has underperformed the market in 2023.
The valuation reflects plenty of pessimism, with shares trading for about 1.8 times sales compared to the pandemic peak of 3 times sales. Home Depot's dividend yield has also risen as the stock price dropped and is approaching 3%.
Patient investors will likely see solid returns from that combination of value and income over the next several years. But Home Depot also appears to be approaching an unusually tough selling period. While a cyclical slowdown is no reason to sell the stock, shares look like a hold right now.
