You Can Build Profits: Home Depot Helps

You can build better and bigger profits in your portfolio, and Home Depot HD may be able to help. The Atlanta-based home improvement company reported second quarter earnings of 86 cents per share on $20.23 billion in revenues. Wall Street had been expecting earnings of 83 cents per share on $19.96 billion in revenues. In addition, the company upped its full year guidance, raising its full year 2011 guidance to $2.34 per share. Wall Street expects earnings of $2.30 per share for the full year. "Our second-quarter results were driven by a rebound in our seasonal business, storm-related repairs and strength in our core categories,” said Frank Blake, chairman & CEO. “We continue to deliver a strong operating performance while also investing in customer service and our merchandising initiatives. I would like to thank our associates for their hard work and dedication. It is their efforts that enabled us to deliver these results.” This is a stark contrast from what its competitor Lowe's LOW had to say a day earlier, when it reported earnings. It is obvious that Home Depot, through its cost cutting measures, has been able to beat Lowe's at the same game. Home Depot expanded into China, and while that venture has not worked out as well as the company had hoped, it is allowing the company to cash in on the world's most important economy. The company once started by Arthur Blank, Ken Langone and others, has been able to drastically turn its image around, from a big box retailer that was unfriendly to consumers. It caters more towards local areas, and store associates have undergone training to cater to their shopper's needs. When a $50 billion company is able to grow earnings 19.4% year-over-year, this is one that makes you stand up and take notice. When the company reports same-store sales were up 4.3%, while Lowe's reported a 0.3% decline in comparable sales, it really makes you take notice. When the CEO on the conference call says the worst parts of the U.S. housing sector, California, Florida, Arizona and Nevada are showing signs of improvement, it may be time to enter the shop. As such, the stock is up more than 5% today, and is in the middle of its 52 week range, hovering just over $33 per share. The high end of the range is $39.38, and the low end is $27.10. Trading at 12.6 times 2012 earnings, and sporting a 3.3 dividend yield, Home Depot appears to be undervalued, especially when the company just raised earnings guidance. Putting a conservative 15 multiple on 2012 earnings, and shares are undervalued by some 20%. The company has been able to generate returns on equity over 18%, which according to Warren Buffett, is the hardest number to fudge. Conversely, Lowe's sports a ROE of just over 10%, so it is clear that Home Depot is operating more efficiently and generating better returns for its business, as well as its shareholders. If you want to build bigger and better profits in your portfolio, it may be time to look at Home Depot. After all their slogan is: "You Can Do It. We Can Help." ACTION ITEMS:

Bullish:
Traders who believe that the U.S. housing sector is coming back sooner rather than later might want to consider the following trades:

• Home Depot should benefit as consumers continue to remodel their homes, as well as build new ones. A trader could put on a pair trade of going long Home Depot and shorting Lowe's.

Bearish:
Traders who believe that Home Depot's operating efficiency has peaked may consider alternate positions:

• If Home Depot has peaked here, then there is nowhere to go but down. It may happen at a slow rate, but if the housing sector never comes back, Home Depot may need to figure out a way to change its business model, or ultimately face extinction.
  
  

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