Motley Fool
I've written in the past that Home Depot (NYSE: HD) was a company to consider as an investment. It's an industry leader that's seen margins expand. It's been a victim of negative sentiment, given real estate concerns and worries about tapped-out consumers. And it has seen purchases from famous value investors.
But digging in and analyzing the company recently, I'm changing my mind. I think Home Depot is a value trap. Not one those "turnaround that never happens" kinds of value trap. This one's a bit different, so let me explain.
The catalyst
Home Depot has been on my mind, especially recently, as its price has been falling. What prompted me to take a bit of a deeper look was a press report that Goldman Sachs analyst Matthew Fassler recently downgraded the company, from "buy" to "neutral," citing management turnover concerns at a time when the big orange beast is working to get its stores in order. At the same time, he upgraded its big blue competitor, Lowe's (NYSE: LOW), from "neutral" to "buy" in the belief that it stands to benefit more from a turn in the housing industry.
The view from Wall Street
To start my analysis, I wanted to see what other analysts thought about the company. Below is a table of the number of analysts rating Home Depot and Lowe's a buy, hold, or sell.
|
| HD 10/16/06 | HD 6/30/06 | LOW 10/16/06 | LOW 6/30/06 |
|---|---|---|---|---|
| Buy | 15 | 14 | 13 | 14 |
| Hold | 13 | 13 | 13 | 12 |
| Sell | 0 | 2 | 3 | 4 |
Data from Jaywalk.
Over the past six months, sentiment has shifted more toward "buy" for Home Depot. However, I think sentiment for both companies is still probably "hold."
The view from Main Street
Have you signed up to participate in our revolutionary new ratings service, Motley Fool CAPS? No!? Then get to it. It provides a great view of what those of us on Main Street think. In fact, here's what the CAPS community thinks about both companies, comparing "outperform" calls with "underperforms."
|
| Total Players: OUT | Total Players: UND | All-Stars: OUT | All-Stars: UND |
|---|---|---|---|---|
| Home Depot | 738 | 152 | 136 | 21 |
| Lowe's | 295 | 26 | 73 | 4 |
It looks like the CAPS community is a bit more bullish on the companies, especially Lowe's.
My view
Within CAPS, there's been plenty of talk about Home Depot Chairman and CEO Bob Nardelli's compensation and treatment of shareholders. And rightly so. But Nardelli is an execution guy-- he cut his teeth at the "Make Your Numbers" university of General Electric (NYSE: GE). How do I know this? Ultimately, he was my boss when I worked at what was GE Power Systems. And although I never had the chance to meet him, his demand for performance was felt throughout the entire organization. So while I agree that he's probably overpaid (blame the executive compensation committees for letting this get out of control) and needs to work on his bedside manner with shareholders (perhaps with a call to Miss Manners), his abilities probably cancel out those negatives.
That's not what bothers me at Home Depot. What bothers me is that great execution seems to be priced into the stock. Here's what I mean.
I know Home Depot has been able to increase margins. I know that return on invested capital, adjusted for operating leases, has been rising -- albeit not as rapidly as in the past. And those are the marks of a great business with a competitive advantage. But stagnant adjusted free cash flow growth (66% at Home Depot and 80% at Lowe's, adjusted for growth capital expenditures) troubles me, especially when you see that it's growing at Lowe's.
Adjusted Free Cash Flow, in Millions
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