Home Depot: Two Reasons I’m NOT Impressed with HD Call Options

Home Depot (NYSE:HD) is one of the most-popular stocks in the market right now as it basks in the euphoria of an impressive fourth quarter earnings result. Home Depot with its market capitalization of $153.87B is a home improvement retailer. The Home Depot stores sell a wide assortment of building materials, home improvement products and lawn and garden products and provide a number of services.

Home Depot reported its fourth quarter (Q4 2014) results yesterday and it would be an understatement to say that traders and investors are impressed with the company. The stock is already up to an intraday high of $117.43. The stock has been trading up nicely in the last one year as it sports 44.04% gain in the last one year to beat the paltry 14% gain recorded in the S&P 500. The stock is up 11.22% in the year-to-date, it is up 10.80% in the last 1 month and it has soared by 4.25% in the last five days.

Q4 Earnings at a Glance

Home Depot reported fourth quarter earnings of $1.00 per share to mark an impressive 36% year-over-year improvement and to beat the consensus estimate of $0.89 per share

The company reported revenue of $19.2B to outperform the consensus estimate of $18.70B

Home Depot raised its quarterly dividend by 26% to mark the sixth consecutive year of dividend increases. In addition, the company has authorized an $18B stock buyback program that will replace the $17B buyback program that was approved in 2013.

Two Reasons I am Not Impressed with Home Depot

Despite the impressive fourth quarter results that Home Depot delivered and the positive response that sent the stock rising to new highs, I beg to differ, and I believe that the shares of Home Depot are rising on the wings of irrational exuberance. Below are two reasons Home Depot cannot realistically support a PE of 25X earnings.

Cost of Data Breach

The first reason I am unimpressed with Home Depot is that the company’s 2015 earnings guidance does not seem to reflect an accrual of losses related to the 2014 data breach. You’ll remember that Home Depot had its data systems compromised between April and September when the information about 56 million cards fell into the hands of hackers.

Home Depot is technically liable for transactional frauds that happen on the cards compromised in the breach and the company will need to reimburse the payment card networks for card fraud cost. In addition, the company is still heavily involved in damage control to restore confidence in its customer and to prevent a reoccurrence of the data breach.

However, Home Depot has pegged the costs related to the breach at $33 million so far; yet, it is unequivocal in saying that its 2015 guidance does not include estimates of the potential costs of the data breach.

Currency Headwinds

The second reason I am not optimistic about Home Depot is the potential fallout from currency headwinds as the dollar continues to strengthen. Home Depot has said that its 2015 financials could feel a negative impact of $1b in revenue and a $0.06 per share drop in earnings if the strong dollar persists and the exchange rate remains intact at current levels.

Hence, the company’s guidance is not as impressive as you would have expected after the top-notch 2014 performance. For instance, the company expects its full-year 2015 earnings to be in the range of $5.11 to $5.17 per share, after accounting for share buybacks and sales growth should be around 3.5% to 4.7% compared to a sales growth of 8.3% in the fourth quarter.

How to Trade HD Options

I am not impressed with the prospects of Home Depot going forward and I recommend a contrarian trade on the stock. For one, the stock is overvalued with a PE of 25X earnings and the stock is in “Overbought” levels with an RSI of 73.07. I recommend the HD May 2015 110.000 put (HD150515P00110000); you’ll do well to look for entry positions on the contract from $1.50.

— Daily Option Alerts

You May Also Like

About the Author: Daily Option Alerts