The Home Depot (HD) reported 2% lower sales for Q2, which was better than expected, and also guided for 2% to 5% lower sales for this year. That's the bad news. The good news is that its free cash flow (FCF) is surging, up 80% YoY in the first two quarters of this year. As a result, HD stock looks like a value play.
The company said that its Q2 earnings per share (EPS) was down 7.92% to $4.65. At least one analyst said that Home Depot blamed the large purchases that were made during the pandemic which are not trailing off, as well as high interest rates.
Nevertheless, a close look at the financial statements shows that during the first half of 2023, Home Depot generated $10.3 billion in free cash flow (FCF), i.e., $12.2 billion in cash flow from operations (CFFO) less $1.7 billion in capex spending.
That was 80% higher than the $5.72 billion in Q1 and Q2 FCF last year (i.e., $7.18b CFFO less $1.46b capex). Moreover, its FCF margins for the first half, at 12.85%, are high (i.e., $10.303b/$80.17b).
This shows that the company is still quite valuable, despite the downturn in sales and earnings.
Valuation Expectations
Analysts surveyed by Seeking Alpha are projecting $14.95 in EPS for the year ending Jan. 2024. As a result, at today's pre-market opening price of $328.55 HD stock trades for 22x earnings.
That is consistent with the stock's long-term forward P/E (price/earnings) multiple averages. For example, Morningstar reports that the 5-year average forward P/E multiple has been 21.08x.
Moreover, for 2024 earnings estimates are at $15.92 per share, giving HD stock a forward 20.6x P/E multiple.
However, the company's massive FCF, as well as its FCF margins, give HD stock a good potential upside.
Contrarian Play and HD Stock Target Price
For example, if we estimate that FCF will hit close to $20 billion this year, based on $152 billion in sales and a 13% FCF margin, HD stock could be worth much more. That is because this puts the stock on a very high FCF yield of 6.0% (i.e., $20b/$331 billion market cap).
A more reasonable valuation would be a 5.0% FCF yield, i.e., 20x FCF using the inverse. So 20x $20b FCF estimate gives us a target market cap of $400 billion. That is 20.8% higher than today's market cap.
In other words, based on a conservative FCF yield estimate and margin expectation, Home Depot is worth about 20.8% more or close to $400 per share (i.e., $1.208 x $328.55 = $396.55 per share).
That makes HD stock a good contrarian play for value investors.
