Home Depot (HD 41) has installed new management and made a complete about-face in its corporate objectives. The “growth by acquisition” offensive of the past five years has been abandoned and replaced with returning cash and capital to the shareholders. The “Home Depot Supply Division,” built through acquisitions, is being sold, with $9.5 billion of cash proceeds allocated to repurchase stock. New borrowings of $12 billion will also fund stock repurchases, for a total reduction of 26% in the number of outstanding shares. In the future, 30% of earnings will be paid out as cash dividends, and all remaining free cash flow will be used to repurchase stock.
New CEO Frank Blake has acknowledged the
relatively slow revenue growth of this huge home improvement retailer, which
continues to deal with a slow home sales environment and with Lowes, a smaller competitor
that has been taking market share. He is
refocusing the company on restoring the positive customer experience which had
been neglected under previous management.
Customers are already seeing improvement in the accessibility and
helpfulness of in-store “associates.” Product
availability is being improved through revitalization of the supply chain, which
simultaneously reduces operating expenses.
Product innovation and excitement is receiving long overdue attention
and the shopping environment for “Pros” (professional contractors) is also a
focus. In short, Home Depot is going
back to its merchandising roots.
The residential
real estate correction in the
We have reduced
our earnings estimates for Home Depot in anticipation of the completion of the
sale of Home Depot Supply, formerly the fastest growing segment of the
company’s business. We project $2.32
this year, excluding non-recurring items, and $3.99 in
2011. This supports an intrinsic value
estimate near $50. Home Depot owns 87%
of its stores outright and unencumbered by mortgage debt. It is illuminating to evaluate it as one
would an income real estate property. Operating
profits before interest and taxes are estimated at about $7.5 billion this year
and $8.5 billion next year, compared to a current market capitalization of
equity plus debt totaling $94 billion.
That gives capitalization rates of 8% and 9%, respectively, making Home
Depot somewhat less expensive than decent income property in the
FLIR (FLIR $48) is the leading manufacturer of thermal imaging and infrared detection systems. “FLIR” stands for Forward Looking InfraRed. Its systems produce a clear monochrome (black and white) image of objects in total darkness, through walls and through obscurants like fog or smoke. The company is organized into three divisions, Commercial Vision Systems, Government Systems, and Thermography (temperature measurement). Historically, most of the company’s sales were to governments for use by defense, search and rescue, and border patrol departments. Other applications include manufacturing process control, navigation safety and land-based security. The price of these systems has dropped sufficiently over many years of development that commercial markets can now be addressed. Commercial markets are huge and offer the prospect of substantial growth for FLIR.
One example of a commercial product is the automobile night-vision system available now on BMW’s as a $2,200 option. The sensor is positioned at the front of the vehicle, and works through the navigation system screen. With a range of 1000 feet, it displays night time hazards at four times the range of headlights. Nautical systems help boat captains see objects ahead of them in the water under dark or foggy conditions. Such objects could be logs, other boats, bridges, or outcroppings of rock. Although commercial vision is currently only 17% of sales, revenue growth of 41% in the last quarter is an indication of its potential impact on FLIR.
Government systems comprise 45% of FLIR’s revenues, and have historically been the big growth driver. This past quarter was no exception, as revenues increased 52% over last year’s comparable quarter. FLIR systems save lives by enabling search crews to find victims through smoke, foliage, fog, and darkness. As an offshoot of this capability, FLIR recently received a contract from the U.S. Customs and Border Protection Agency for sensor systems that monitor border incursions. Military applications include a significant long-term contract to supply the BRITE STAR II laser designation system for the U.S. Army’s Armed Reconnaissance Helicopter Program.
FLIR’s thermography division contributes 38% of sales and grew 18% last quarter. The systems have a myriad of uses, including building inspections to find water and gas leaks, medical exams to find breast cancer and arthritis, jet engine engineering and design, heat signature tracking, and asphalt road construction and condition analysis.
FLIR got off to a great start in 2007 with first
quarter revenue growth of 37.5%.
However, management is guiding to full year revenue growth of 23% to
27%, indicating its expectation of slower growth later in the year. This still compares favorably to last year’s
13% and the preceding five year’s compounded annual growth rate of 22%. International sales compose 42% of revenues. Analyst consensus earnings estimates for 2007
and the following four fiscal years are $1.63, $1.90, $2.26, $2.69 and $3.20,
respectively. An estimate of intrinsic
value is in the mid-$40 range. Risks
include new products from competitors, the timing of orders as evidenced by
historical sales growth volatility, limited sources of supply of product
components, and intellectual property enforcement exposure.
Steven L. Ré, CFA July 12, 2007
This report contains the current opinions of the author and such opinions are subject to change without notice. It has been distributed for information purposes only and is not to be construed as a recommendation to purchase or sell securities. The information contained herein is from sources deemed reliable but is not guaranteed. It should not be assumed that investments in any of the above-mentioned securities will be profitable, and past performance is no guarantee of future results. Earnings projections often miss, and markets go up and down. The employees and families of Quality Growth Management, Inc. may own the above-mentioned securities in their own accounts, and may trade them at any time without notice.