Showing posts with label HD. Show all posts
Showing posts with label HD. Show all posts

Friday, March 22, 2019

HD nailing another call on Home Depot

I write extensively about Home Depot.    We all know the stores are really busy.  Your choices for home refurbishing include Lowes, and Orchard Supply maybe True Value or ACE.  But most of us find Home Depot to be closest to our homes. 

The negative on HD, as I have noted many times, is the amount of debt: 17.68 and growing.  The positives are the growth of the dividend.  Dividend growth over the past three years has averaged 32.36% per year.  You certainly don't need to worry about inflation with that kind of income growth.  Unless you're a politician or a professional athlete or an entertainer, you can't get that kind of income growth from your work.

I own Home Depot but am nervous about any holding in my portfolio that carries a lot of debt.  If I get rid of HD, I lose the dividend of 2.86% and the dividend growth.  My theory is I can find another stock with a similar yield and dividend growth with less debt.  But, it is not that easy.  AbbVie, symbol ABBV, has just over 22% per year dividend growth for the last 3 years.  ABBV also has balance sheet issues. FedEx, symbol FDX, has raised the quarterly dividend from $.25 March of 2016 to $.65 in March of 2019 or an average annual increase of 53%.  FDX carries a dividend yield of 1.5% and reasonable D/E ratio of .76.

Notice, I am not so worried that I am selling HD outright.  I hold it in a retirement account and do not have to worry about tax implications of the capital gain.  I also am not adding at this time.

Call Options using my personal basis.

In stead of selling it outright, I work the calls.  I just had a $185 call expire on March 15, 2019.  I have $190's working with an expiration date of May 17, 2019.  Based on the price today, I will most likely lose it.  Yet, that is what I thought about the $185.  Like 90% of calls, that $185 expired with no action.

$200 Strike with May  expiration

Today I sold another call on the shares not on call.  I like the $200 strike.  I will not get the dividend as the call expires prior to the ex dividend date.   Take a look at the math and you can see the call is worthy.

June expiration with $205 strike

For the investor with more appetite for risk and a low cost basis here is what a June expiration with a $205 strike price gets you.   Notice because the call expires after the next expected ex-dividend date, you should get the next quarterly dividend.  And you are more protected from upside potential.  Equally, you are stuck with your shares should they plummet while your option contract is in force.

While, I am not adding Home Depot at this time, for investors who are considering beginning a position and selling these calls on the new position, here is how they would fare using a cost basis from a trade today.

Call Options using today's basis 

May Expiration and $200 Strike Price today's Basis

To me the meager addition of income from this call is not worth the risk.  However, investors interested in going out further could consider the next call.

June Expiration and $205 Strike Price today's Basis

Home Depot has been a great stock for nailing income from dividends and calls.  I will not be sad if I lose it and I will not be adding today, but I enjoy working the calls in this up and down market.  After all, my priority is income investing.

M* MoneyMadam
Disclosure:  Long HD with calls
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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
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