(Sept 23): Our investments in Home Depot and Northrop Grumman have done well, sitting on gains of 16.5% and 19.5% respectively. We believe our investment thesis for both stocks remains intact.
Home Depot
Home Depot (HD) is the world’s largest home improvement retailer, operating primarily in the US market. It also has stores in Canada and Mexico.
The company has delivered a solid track record of sales and earnings, registering positive growth every year since 2010, after the global financial crisis. Free cash flow has also improved over the years, resulting in rising dividends for shareholders.
Its latest earnings results, for 2QFY2019, were slightly above consensus, which spurred its share price higher. This, despite top-line sales that missed expectations mainly because of lumber price deflation. Some of the highlights include improved y-o-y sales by 1.2% to US$30.8 billion ($42.4 billion), with comparable sales up 3% y-o-y. Diluted earnings per share (EPS) rose 3.9% to US$3.17.
Our original investment in HD was predicated on expectations of robust US consumer spending, which has proven true with this latest set of results. A stable housing market, falling mortgage rates, ageing housing stock, population growth and increasing housing turnover are all supportive of our investment thesis.
Company guidance for the remainder of the year remains broadly positive. Management reaffirmed a diluted EPS estimate of US$10.03, but pared back sales growth to 2.3% (from 3.3%) and same-store sales growth to 4% (from 5%) — taking into account deflation in commodity prices as well as higher tariffs resulting from the US-China trade war. HD also plans to continue with its share buyback plans.
Looking beyond the short-term headwinds, we continue to like HD’s approach to improving the value, scale and efficiency of its business amid a rapidly changing retail environment.
For instance, customer experience (a key contributing factor to HD’s market-share moat) has seen improvements through the implementation of way-finding signs in over 1,400 US stores and front-end store investments in over 400 stores nationwide. Customer satisfaction scores improved 1.4% and 4.5% respectively, thanks to these investments.
HD intends to invest about US$2.9 billion in e-commerce and mechanisation through 2022 to further drive online customer satisfaction and efficiency. This will enhance online engagement of customers. Online sales have been a key growth driver, up 20% y-o-y in 2QFY2019.
Elsewhere, the company is also investing in the popular automated pickup lockers for online orders, which was rolled out in more than 1,100 stores. It reported a 2.5% increase in checkout scores for stores with lockers versus those without over the quarter. About 50% of all online US orders were picked up in HD’s physical stores in 2QFY2019.
Unsurprisingly, HD’s balance sheet and key financial ratios are strong. Case in point: It has a current ratio of 1.1 times and interest coverage ratio of 14.8 times. For 1HFY2019, HD’s gross and operating margins stood at 34% and 14.8% respectively.
In addition to potential capital gains, its 2.4% dividend yield is also fairly attractive, benchmarked against the prevailing risk-free yield (10-year Treasury) of only 1.8%.
Northrop Grumman
Similarly, defence and aerospace contractor Northrop Grumman posted another convincing set of results for 2Q2019, beating market expectations on both its top and bottom lines.
Revenue and earnings before interest, taxes, depreciation and amortisation (before stock-based compensation) grew 19% and 10% y-o-y, boosted by the inclusion of Orbital ATK, which was acquired in 3Q2018. Meanwhile, cash flow from operations increased 22% over the same period.
Mirroring this strong earnings performance, the stock has done very well so far this year, and is now trading near all-time-high levels.
The outlook for the defence and space sector remains upbeat. The sector is generally insulated from economic cycles. Confidence in the defence stocks also reflects the rising geopolitical tensions around the world, particularly in the Middle East.
The Trump administration has made military spending a key focus area. More resources are being committed to maintain the country’s military prowess and dominance, including for weapons modernisation such as in electronic warfare systems and technology-enhanced products, cybersecurity, and nuclear and space programmes.
US lawmakers recently passed a two-year military budget totalling US$738 billion and $741 billion for 2020 and 2021 respectively. Defence spending has been rising annually, from US$586 billion in 2015.
Northrop reported increased order backlog, by about 10% to US$63 billion in 2Q2019, up from US$57.3 billion in 1Q2019, underscoring its continued momentum in contract wins.
Some of its iconic designs are the B-2 Spirit and, soon, the B-21 Raider next-generation stealth bomber aircraft. It is also a major subcontractor for Lockheed Martin Corp’s F-35 stealth fighter jet. Northrop is a leading player in the mobile robots market, with products such as the Global Hawk and Triton surveillance drones.
The company has just announced a partnership with Aerojet Rocketdyne Holdings to bid for the Ground Based Strategic Deterrent System (GBSD) — the missile modernisation programme to overhaul 400 ageing intercontinental ballistic missiles (ICBM) and supporting infrastructure estimated to cost north of US$100 billion over a decade. Northrop is the only remaining contender after Boeing Co withdrew from the bid in July. Orbital ATK and Aerojet Rocketdyne are the only two US manufacturers of large solid rocket motors.
Elsewhere, NASA recently awarded the design, development and production of the Minimal Habitation Module for the Lunar Gateway to Northrop, over four competitors, as it was the only company that could meet its schedule. The habitation module is targeted for launch in December 2023. The Gateway is a mini space station orbiting around the moon that will function as a stopover and safe haven for astronauts. These projects underscore Northrop’s strong competitive position in the industry.
The Global Portfolio gained 0.9% for the week ended Sept 19, better than the 0.3% increase for the MSCI World Net Return Index. Northrop was the best-performing stock for the week, up 5.2%.
Total portfolio returns now stand at 11.4% since inception. This portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 8.3% over the same period.
Next week, we will write on our newly acquired positions. We decided to increase our overall exposure despite the Dow Jones Industrial Average’s hovering near all-time highs, as we remain convinced of near-term consumer strength in the US and that President Donald Trump will declare victory in his US-China trade negotiations, regardless of the actual outcome.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story first appeared in The Edge Singapore (Issue 900, week of Sept 23) which is on sale now
