$HD Earnings Preview

by Enis May 20, 2013 1:20 pm • Commentary

Event: HD reports their fiscal Q2 earnings tomorrow morning prior to the open. The options market is implying about a 3.5% move vs the 4 qtr average of 3.75%, and the 8 qtr average of a bit higher than 3%.

Sentiment:  Wall Street analysts are slightly bullish on the name with 16 Buys, 13 Holds and 2 Sell with an average 12 month price target of ~$76.50, or right current levels.  Negligible short interest at around 2% of float.

Option Open Interest:  Open interest is heavily skewed to puts, by a ratio of 1.4 to 1, with the largest open interest on the June 75 and 72.50 put lines.  The 1 month volume has been evenly split between calls and puts.

Vol Snapshot:  Implied Vol is really low going into the event with June just under 20. IV typically saw the mid 20’s leading into earnings over the past year. Part of the reason for that lies in the fact that realized volatility has been so low recently. Here’s a look at IV30 (red) vs HV30 (blue):

Screen Shot 2013-05-20 at 10.55.42 AM
from LiveVol Pro

Implied vol should fall even farther following the report with June likely to see 16 depending on the direction and strength of the event move.

Price Action/ Technicals:  Since the end of 2011, HD has been in one of the steadiest uptrends you’ll ever find.  Its 100 day moving average (green) has barely breached for the past 18 months, and it has not even gotten close to touching its 200 day moving average (black) in that period:

2 year daily chart of HD, courtesy of Bloomberg
2 year daily chart of HD, courtesy of Bloomberg

That’s what Carter Worth of Oppenheimer likes to call a “ruler stock”.  Just draw a straight diagonal line in the direction of the trend, and hardly any disturbances from that line.

The stock has almost tripled in that period, an incredible gain considering that HD is now a $115 billion market cap big box retailer, second only to Wal-Mart in terms of market cap in classic brick-and-mortar retail.  It is further above its 100  and 200 day ma than at most times during this trend, but that’s about the only hint of a negative to be found in the technicals here.

Fundamentals / Valuation:  Home Depot has a strong set of fundamental tailwinds.  To name a few:

-Rising home prices are driving a renewed interest in renovation and home improvement, as homeowners become more interested in investing in their homes.

-Low interest rates continue to encourage ongoing construction growth, especially given the low base of activity in the past 5 years.

-Increasing market share for HD among remodeling and renovation firms

-Home Depot is an efficiency machine.  It has reduced costs by more than $1 million per store per year as part of its operational improvements.

The issue with HD is – how much of this is priced in?  Look at the 10 year chart of the trailing P/E for HD stock:

10 year chart of trailing P/E for HD, Courtesy of Bloomberg
10 year chart of trailing P/E for HD, Courtesy of Bloomberg

It is at its highest valuation in 10 years, by quite a bit.  Even if current projections of 15% earnings growth are achieved, it still does not seem to have much room for further gains.  But HD’s valuation multiple has been expanding for years now, so it’s tough to know when the appetite for HD shares among investors will finally ebb.

My View:  This is a stock that is quite rich on a valuation basis vs. its own history, and vs. most other comparable companies in the market.  But it’s been a one-way train higher since late 2011, so I have little interest in initiating a trade on HD simply based on extended valuation.  I wouldn’t touch this stock from the long side, but I would stay away from any short-biased trades as well, preferring to wait for some more concrete signs from the market that sellers might be taking control.  Regardless, it’s been a historic run for HD, now one of the largest retailers in the world.