D.A. Davidson's Michael Baker: Home Depot's stock will likely react before mortgage rates go down

Key Concepts

• Home Depot earnings miss (bottom and top line)
• Full-year outlook maintained
• Same-store sales (comps)
• Ticket growth
• Consumer spending trends
• Federal Reserve (Fed) rate cuts
• Mortgage rates (30-year)
• Tariffs and pricing strategy
• Competitive landscape (Home Depot vs. Lowe's)
• Pro customer segment
• SRS and GMS acquisitions
• ICE (Immigration and Customs Enforcement) activity impact

Home Depot's Q2 Earnings and Outlook

• Home Depot reported its first earnings miss on both the bottom and top line since May 2014.
• Despite the miss, the stock is trading higher because the company maintained its full-year outlook.
• The comps were only slightly light of expectations.
• The best same-store sales number that they've had in more than two years.
• Ticket was up and the spread versus their comps in the industry were the best since 2021.
• July was the best month of the quarter and the best month of the year, indicating improving underlying demand.

Impact of Interest Rates and Fed Policy

• The analyst believes the stock will react positively before mortgage rates actually fall.
• The Fed is expected to cut rates at least once later this year, with more aggressive cuts anticipated in 2026.
• A 75 to 100 basis point cut in rates could bring the 30-year mortgage rate to a "five handle" (e.g., 5.9%), which would be positive for both the stock and sales.
• Consumers are expected to increase home improvement spending when they see lower mortgage rates.
• The average spread between the fed funds rate and the 30-year mortgage rate is typically around 2.5 percentage points.

Pricing Strategy and Tariffs

• Approximately 50% of Home Depot's products are sourced domestically, and 50% are sourced internationally.
• Tariffs are not significantly impacting the bottom line but are contributing to sales growth through selective price increases.
• Home Depot has been less promotional in some categories, leading to a slight decline in comp transaction count but higher ticket growth.
• This strategy is seen as a way to protect margins in light of tariffs.

Competitive Landscape: Home Depot vs. Lowe's

• The competitive spread between Home Depot and Lowe's has been widening in Home Depot's favor in recent quarters.
• Home Depot's success with the Complex Pro customer segment, driven by the SRS and GMS acquisitions, is a key factor.
• The SRS acquisition was made a year ago and the GMS acquisition was made this summer.
• This segment faces less competition and is contributing to the widening comp spread.
• The analyst will be watching Lowe's report tomorrow to see if the spread of about 1% to 1.5% holds this quarter.

ICE Activity and Potential Impact

• There has been anecdotal evidence of ICE arrests targeting home improvement retail properties, particularly Home Depot.
• This issue was not addressed on the earnings call, despite being a relevant question for analysts.
• The analyst intends to ask about this on a follow-up call.
• The strong comps suggest that ICE activity has not significantly impacted sales, as comps were broad-based by category and region.

Analyst Recommendation

• The analyst has maintained a "buy" rating on Home Depot for several quarters, advising investors not to wait for changes in mortgage rates or the housing market.
• The price target remains at $450.

Conclusion

Despite a recent earnings miss, Home Depot's underlying performance shows signs of improvement, driven by strong same-store sales, ticket growth, and success with the Pro customer segment. The company's strategic pricing adjustments in response to tariffs, combined with anticipated Fed rate cuts, position it favorably for future growth. While the potential impact of ICE activity remains a question, the overall outlook for Home Depot is positive, as reflected in the analyst's continued "buy" recommendation.