Wednesday, February 20, 2019

Home Depot pros and cons

Home depot symbol HD is a prodigious dividend growth stock.  This is a positive for income investors.  The negatives on HD are the puny yield of 2.15% and a debt to equity ratio that has ballooned to 19.53.

Dividend growth is very important.  I have written about this so many times.  Pay no attention to formal inflation statistics.  Look back 20 years and you will see your basic expenses double in that time.  I don't work anymore and cannot get raises unless my income instruments raise their payouts.  The first graph below shows recent dividend increases by HD.

I call the yield of 2.15% puny because today you can buy an FDIC (federally insured) one month C.D. that pays 2.01%.  The only reason to take the risk on HD is the dividend increases. 

Look at this chart of HD's debt to equity ratio and you can see they borrowed a ton of money recently.  Clearly low interest rates make that borrowing look smart but what happens when they need to roll that debt.  Will they be stuck with higher interest rates?  Could those interest payments cut into the cash available to raise the dividend.

Certain industries do need to use a lot of debt to fund their operations, and this industry does carry quite a bit of debt. Look at the comparison of D/E ratio among HD's peers.  Lowe's debt to equity is 2.89.   This D/E ratio is still high but not as high as HD's. 

Will the debt impact HD's ability to pay the dividend and continue to increase the dividend?  In the next graph, cash flow is added and it appears that HD is capable of servicing this debt as cash flow has increased right along with the increased debt.

Something has to give and it is shareholder equity.  The third graph shows what happens to shareholder equity in view of this debt.

I own HD and have call options expiring in March and April.  I use the calls to boost the income from HD.  My basis is $148.92.  Should I have risked losing HD to the call buyer?  My strike prices are $185 and $190 respectively.  Most likely, I will lose my shares. 

My loss will be any opportunity from HD's stock price soaring even more.  This is called lost opportunity.  Perhaps this will happen but I don't suffer over spilled milk.   I am more worried about finding a stock where the dividend increases significantly and I can boost annual income by using calls.  

Should I initiate a new position?  Calls are good.  Take a look at this call available today. 


This call calculator illustrates that in fewer than 60 days, you could bag a quick 8.33%.  Or your call could expire and you have boosted  you income by the value of the call premium while you wait for your next dividend increase.

Only you can decide to buy now and sell a call or to buy and hold.  I am going to pass on this trade.  My reason is risk management.  I just need to keep income stocks with pristine balance sheets.   I can make many arguments that support HD management's decision to boost shareholder value through stock purchase buybacks funded with debt.  I prefer a stock that boosts shareholder value through more revenue, more earnings and more free cash flow without the risk of interest rate increases.

M* MoneyMadam

Disclosure:  Long HD with calls