2 Reasons Home Depot Is A Smart Defensive Play Even After A Massive Rally

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Finding the right defensive retail stock for your portfolio keeps getting tougher. Brick-and-mortar retailers are facing a tough frontal attack from online disruptors such as Amazon (NASDAQ:AMZN), which increasingly threatens their survival.

Indeed, over the past decade there has emerged a graveyard filled with an assortment of marquee retailers who failed to figure out a way to survive in an environment where each year shoppers were making fewer and fewer trips to malls, and millennial consumers were finding it increasingly convenient to order online. Among the growing list of retail failures and bankruptcies, however, there are still some success stories as well. The Home Depot (NYSE:NYSE:HD) is one of them.

2 Reasons Home Depot Is A Smart Defensive Play Even After A Massive Rally

HD Weekly 2015-2018

The hardware and household-improvement chain has proved many forecasters wrong about its management’s ability to come up with a hybrid business model where e-commerce strategies can help supplement brick-and mortar operations.

Home Depot has delivered year-over-year comparable sales growth for 29 straight quarters. This consistently strong performance over such an extended period is obviously noteworthy. Quarterly sales growth has been more than 4% for the bulk of that time. It indicates that this big box retailer is pursuing an extremely successful growth strategy.

Its stock price is clearly reflecting that strength. During the past decade, Home Depot shares surged about seven-fold, compared to 188% gains in the benchmark S&P 500 Index. Over the past 12 months, HD stock rose 28%, about double the gains delivered by the benchmark index.

Currently trading at $207.60 as of yesterday’s close, the stock is barely 4% below its record high of $215.43. Does it make sense to buy Home Depot shares after such a powerful rally? The short answer is yes.

We believe it’s a great defensive stock to own if you want to play the strength of the US economy and earn decent dividend income. Here are the top two reasons why we like this stock:

1. Successfully Fending Off the Amazon Threat

Home Depot is one of those retailers that are best-positioned to survive an ongoing onslaught by the e-commerce giant. The reason: HD management figured out early on how to thrive in this challenging environment.

With 90% of Americans already living within 10 miles of a Home Depot store, rather than opening new locations, the company instead focused on upgrading its existing store base with better technology and e-commerce fulfillment capabilities.

By strengthening its relationship with its most loyal customers and improving its online delivery operations, HD has been successful in retaining customers. For example, HD is spending heavily to incentivize its customer network of contractors whom it calls “pro.” According to Carol Tomé, Home Depot’s chief financial officer, these pros only comprise about 3% of Home Depot’s customer base, but they account for about 40% of its sales. The retailer is making sure it stocks brands that these contractors like and is making it easier for them to pick up online orders quickly at stores.

Another factor favoring this home improvement retailer: this segment has been least affected by the Amazon disruption. Only 5.2% of hardware and home improvement sales occur online, while 27% of apparel and accessories sales are completed through online channels, according to data compiled by Bloomberg.

2. Roaring US Economy; Housing Strength

Investing in Home Depot is also a good way to play the strength of the US economy. Rising home prices, which are near their pre-housing-bust peaks, are encouraging homeowners to spend on home improvements projects, such as installing new kitchens and remodeling bathrooms.

And Home Depot is reaping the benefit of these good times. In the second-quarter, its comparable sales rose 8% over a year earlier, a strong jump that exceeded analyst expectations. For the full year, Home Depot raised its guidance, expecting a 5.3% increase in comparable sales and $9.42 diluted earnings per share.

The last big housing recession, which began in 2006, has prepared the company to deal with economic cycles more effectively than other retailers such as Wal-Mart (NYSE:WMT). During that period, Home Depot developed rapid deployment centers throughout the US that were critical to the company’s plan for managing distribution and inventory more efficiently. Previously, Home Depot had simply used its stores as warehouses.

Bottom Line

Home Depot stock has had a remarkable run over the past year. But if you factor in its future growth potential, this stock still looks attractive. Plus, with its forward price-to-earnings multiple of 24.3, it doesn’t look expensive.

As well, this retailer is a reliable dividend payer. Its quarterly dividend is currently $1.03 a share, for a yield of just under 2%, with a healthy payout ratio of 45.18%. Even more encouraging, Home Depot has raised its dividend more than 350% during the past decade.

This is a stock that should definitely be on your radar, even if you don’t want to enter the trade at these high levels. If that’s the case, keep an eye out for the next dip. It just might give you a good opening.

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