Cyclical downturns are an unavoidable aspect of competing in the home-improvement world. Consumers reduce their spending trends in response to things like slowing economic growth, rising interest rates, and inflation. Then they tend to allocate more cash toward these discretionary home purchases when they're feeling more optimistic about their personal finances.
These economic pressures are all contributing to the sales pressures Home Depot (HD 0.94%) and its rivals are feeling today. But the retailer has endured many cyclical slumps through its time leading the industry and has always emerged from these periods to set new annual sales and earnings records. With that big picture in mind, let's zoom out and look at Home Depot's prospects over the next several years.
The latest results
Everything investors know so far points to a challenging period ahead for the retailer at least through the end of 2023. Management in mid-August affirmed their outlook calling for sales to decline by between 2% and 5% this year, roughly erasing 2022's 4% increase. The chain is seeing the same pressures affecting peers across the retailing industry, from Target to Best Buy, as spending shifts away from discretionary purchases and more toward essentials.
Home Depot is seeing pockets of strength, though, even in this tough selling environment. Consumers are spending eagerly on smaller home projects even as they pull back on big-ticket items such as appliances. Customer traffic trends are also stabilizing, with last quarter's 2% decline marking a solid improvement from the prior quarter's 5% slump.
And profitability is holding up well despite pressures including falling sales and lumber price deflation. "We were pleased with our performance in the second quarter," CEO Ted Decker told investors on Aug. 15.
Optimism about the future
There are reasons to expect good things from Home Depot over the next several years beyond the potential for a modest industry downturn in the short term. Several structural trends suggest strong growth for the home-improvement market, including the average age of housing stock, favorable demographics as more millennials shop for new homes, and the tilt toward remote work that's opening up new areas for home development.
Rival Lowe's (LOW -0.04%) highlighted these tailwinds in a recent conference call with analysts. "All of these factors continue to make us bullish on the mid- to long-term outlook for our industry," CEO Marvin Ellison said in late August. Home Depot, as the market share leader, can reasonably expect to win a larger proportion of this growing pie. "We remain very positive on the medium-to-long term outlook for home improvement and our ability to grow share in a large and fragmented market," executives said in August.
The stock's path
Home Depot's stock's valuation is sitting at about 2 times annual sales today. The pandemic peak valuation was at 3 times revenue, while recent lows were about 1.8 times sales. Lowe's, which trails its larger rival in metrics such as profit margin and market share, is valued at a cheaper 1.5 times sales. Home Depot is also slightly more expensive when it comes to price-to-earnings, with a valuation of 23 times earnings compared with Lowe's and its 20 P/E ratio.
Still, it seems likely that Home Depot will be setting new profit and earnings records in a few years. There's a small chance that this rebound will start as early as 2024, given the potential for just a minor sales shortfall this year.
In any case, shareholders can reasonably expect solid returns from this retailer as Home Depot wins more market share and continues returning cash to investors through share buybacks and dividend payments. Investors are likely to be happy they held the stock through this turbulent period so they can benefit from the inevitable rebound in the home-improvement market over the next several years.
